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Structuring Enforceable Contracts in the Cannabis
Industry: Managing Risk Under State and Federal LawSubject Matter Description and Contract Invalidation, Choice-of-Law
and Marijuana-Friendly Courts, Arbitration Provisions
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WEDNESDAY, MARCH 20, 2019
Presenting a live 90-minute webinar with interactive Q&A
Jeffrey S. Gard, Founder, Gard Law Firm, Boulder, Colo.
Kathryn L. McCall, Partner, Sideman & Bancroft, San Francisco
Katy M. Young, Partner, Ad Astra Law Group, San Francisco
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STRUCTURING ENFORCEABLE CONTRACTS
IN THE CANNABIS INDUSTRY
Gard Law Firm
2541 Spruce Street
Boulder, CO 80302
(303) 499-3040
www.gardlawfirm.com
www.marijuanalawscolorado.com
5
OUTLINE
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• Overview of Cannabis Illegality and Risks
• Types of Contracts
• Enforceability Issues
• Choice of Law Provisions
State Marijuana Laws Effective July 2018
33 States and
Washington DC
allow medical.
10 States and
Washington DC
allow adult use.
7
RISKS OF ENTERING INTO A CONTRACT IN
THE CANNABIS INDUSTRY
• Cannabis is illegal federally.
• Contracts with marijuana businesses should always
contain choice of law and venue provisions.
• Unlike other contracts, the choice of law MUST be the
state where the business is licensed, and the venue MUST
be in the state where the business is licensed.
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TYPES OF CONTRACTS
• Cannabis Distribution Agreement
• Company Acquisition Contracts
• Membership Interest
Agreement
• Asset Purchase Agreement
• Employment Agreements
• Licensing and Trademark
Agreements
• Management Agreement
• Operating Agreement
• Product
• Consult
• Manufacturing
• Testing
• Promissory Notes
• Transport
• Future Ownership
• Leases
9
CANNABIS-RELATED CONTRACT
ENFORCEABILITY ISSUES
• Parties may attempt to use federal law as a defense to breach of a contract since the contract is illegal under federal law.
• Place an express provision in the contract to provide that federal law shall not be a defense to breach of the contract.
• Add termination clause to allow the agreement to be terminated or ended under circumstances specified in the clause.
• Activities that are legal under state law but illegal under federal law rely on courts or state legislatures to decide whether the contracts involving the activity are illicit and therefore void under contract law.
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RECENT JUDICIAL DECISIONS
• Marijuana business contracts are generally enforceable.
• In West v. Portnoy (Arapahoe County), a marijuana contract was found to be enforceable.
• California recently revised its Contract law to protect Cannabis Contracts on January 1, 2018.
• Colorado Statute C.R.S. 13.22.601: Contracts pertaining to marijuana enforceable.
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SUBJECT MATTER
• How you describe the contract subject may influence a
court’s determination of legality.
• May be beneficial to use broad descriptions of marijuana
products or services to avoid blatant illegality concerns.
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CHOICE OF LAW
• Contracts with marijuana businesses should always contain choice of law and
venue provisions.
• Unlike other contracts, the choice of law MUST be the state where the
business is licensed, and the venue MUST be in the state where the business is
licensed.
• Colorado: Enforceable by State Statute
• C.R.S. § 13-22-601 Contracts pertaining to marijuana enforceable:
“It is the public policy of the state of Colorado that a contract is not void
or voidable as against public policy if it pertains to lawful activities
authorized by section 16 of article XVIII of the state constitution and
article 43.4 of title 12, C.R.S.”
• Pay attention to form contracts from national businesses.
13
CONCLUSION
• Marijuana law is rapidly changing.
• It is important to keep up with pending law changes otherwise clients
may miss business opportunities or be unprepared.
• City council meetings.
• Local news sources.
• Marijuana-specific news sources.
• Marijuana contracts are unique and must be drafted carefully.
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Gard Law Firm2541 Spruce Street
Boulder, CO 80302
(303) 499-3040
www.gardlawfirm.com
www.marijuanalawscolorado.com
15
Structuring Enforceable Contracts in the Cannabis Industry
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Kathryn L. McCallSideman & Bancroft, [email protected]
B E S T P R A C T I C E S W H E N D R A F T I N G A G R E E M E N T S F O R T H E C A N N A B I S I N D U S T R Y
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Drafting the Agreement
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Issues to Consider
Who are the Parties?
Are both parties to the agreement in the cannabis industry?
Is just one party to the agreement in the cannabis industry?
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Think about unintended
consequences:
Payment Provisions
Payment provisions based on a share of the profits of a cannabis business could cause the party receiving the payments to be classified as an “owner” or “holder of a financial interest” of the cannabis business.
Royalties
Revenue Shares
Commissions
In California, a holder of a financial interest in a cannabis business must be disclosed in the cannabis license application.
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Think about unintended
consequences:
Control
Participation in the direction, control, or management of a cannabis business could cause the party exercising such control to be classified as an “owner” of the cannabis business.
Investors
Consultants
Landlords
In California, an owner must be disclosed in the cannabis license application, be fingerprinted, etc.
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Additional Provisions For Cannabis Contracts
Compliance with cannabis rules and regulations.
Changes in state and local laws with respect to commercial cannabis activity.
Termination provisions.
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E N S U R I N G A L L P A R T I E S A R E I N C O M P L I A N C E W I T H T H E L O C A L A N D S T A T E
L A W S , R U L E S , A N D R E G U L A T I O N S R E G A R D I N G C O M M E R C I A L C A N N A B I S
A C T I V I T Y
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COMPLIANCE WITH LOCAL AND STATE LAW
Compliance with Local and State Law
Representations and warranties from the cannabis company that it has obtained all approvals, permits, and licenses to operate its business.
Obligation to timely comply with all local and state cannabis rules and regulations.
Reports
Fees
Taxes
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Compliance with Local and State Law
Maintain in good standing all permits and licenses required to operate the cannabis business.
Provide copies of local permits and state licenses.
Obtain any additional permits or licenses necessary to operate the cannabis business.
Rules and regulations are subject to change and the cannabis business should be monitoring and complying with any new or revised rules and regulations.
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Compliance with Local and State Law
Notification of:
any violation, suspension or cancellation of any permit or license to operate the cannabis business; and
any sanctions or penalties by any governmental authority
NOTE: Consider materiality – require notification of only those violations, suspensions, sanctions or penalties which could have a material adverse effect or result in a material injury to the financial condition, business or reputation of the other party.
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CHANGE!
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The Only Constant in the Cannabis Industry
Changes in the Law
Recognition that the cannabis industry is rapidly evolving and heavily regulated.
Enable the parties to negotiate an amendment of the agreement for:
Changes in the cannabis laws, rules, and regulations;
Changes in federal law enforcement priorities;
Terms that are deemed to be illegal by any state or local court or government agency.
28
Changes in the Law
Consider the threshold required before the parties are obligated to amend the agreement:
Who determines amendment is necessary or advisable?
Sole discretion of one party or the other?
Confirmation in writing by counsel of one of the parties that amendment is necessary or advisable?
Only amend if necessary or amend if advisable?
Amend the agreement only if the parties are likely to be in violation or are in violation of any statute or ordinance.
29
Changes in the Law
Agreement shall be interpreted to ensure compliance with all laws, rules, and regulations applicable to the cannabis industry.
If any applicable licensing authority determines that the agreement needs to be modified to assure compliance, obligate the parties to negotiate such amendment in good faith.
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GET ME OUT OF HERE!
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Termination Provisions
Termination Provisions
Enable the parties to terminate the agreement if:
either party determines that federal enforcement priorities change such that either Party is in jeopardy of civil or criminal investigation or penalties for performing their obligations under the agreement, or
the local or state laws change such that performance of the parties’ obligations under the agreement become illegal.
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Termination Provisions
If the parties cannot agree on an amendment of the agreement required by a change in applicable law;
If a party refuses to negotiate an amendment of the agreement due to a change in applicable law;
If the parties can’t agree that that an amendment is necessary due to a change in applicable law;
THEN, allow either party to terminate the agreement.
33
Other Considerations
Indemnification: Include indemnification for sanctions or penalties assessed for failure to maintain required permits and licenses.
Insurance: Insurance remains difficult to obtain for cannabis businesses.
Payments: Cash
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Questions?
Kathryn L. McCall
Head of the Cannabis Industry Team at Sideman & Bancroft, LLP
Kathryn McCall focuses on helping early stage and mature companies, aswell as family-owned and life-style businesses, succeed. Her clientsappreciate her pragmatic and strategic advice regarding their entityformation, business financing, and operational concerns. As outside generalcounsel for many of her clients, Ms. McCall advises businesses on a widevariety of corporate and other legal matters. In addition, she has extensiveexperience counseling businesses in all aspects of the business life cycle fromthe initial structuring and formation of the business to financing thatbusiness; hiring employees; corporate governance; day-to-day operations;negotiating licensing and other commercial agreements; equity incentiveplans; and liquidity events. She advises corporations, boards of directors,investors, CEOs and CFOs, and business owners on a wide range of corporateand securities transactions, including mergers and acquisitions, securitiesofferings, venture capital, joint ventures, and corporate finance. She hasworked with clients in a variety of industries, including: media; technology;internet of things; education; internet-based products, services, andapplications; consumer products; retail; publishing; and health and fitness.
Ms. McCall also assists businesses in the cannabis industry develop thenecessary infrastructure and organization to succeed while remaining incompliance with the complex legal and regulatory framework burdening theindustry. Working with other members of the firm’s well-rounded cannabisindustry team enables her to create a strategic and coordinated approach tonot only business structuring and organization as well as intellectualproperty, tax, and estate planning.
Ms. McCall is a mentor at Draper University advising budding entrepreneursregarding the legal aspects of starting and running a business. She alsospeaks regularly at Draper University on legal issues facing startups.
Prior to joining Sideman & Bancroft LLP, Ms. McCall was Of Counsel withCarr & Ferrell LLP in Menlo Park, California.
36
Structuring Enforceable Contracts in the Cannabis Industry
Katy M. Young, Esq.Managing Partner
Ad Astra Law Group, LLP582 Market Street, 17th Floor
San Francisco, CA 94104(415) 795-9875
Structuring Enforceable Contracts in the Cannabis Industry
• Breach of contract actions are abundant in the cannabis industry. Why?
• The Culture Clash• Industry Pioneers
• Cowboy Personality or Kumbaya/Can’t we all just get along• Varying levels of sophistication• Varying levels of capitalization
• Business Community• The Movement or the Money • Generally more sophisticated, easily frustrated by some industry pioneers• Generally better capitalized
38
Structuring Enforceable Contracts in the Cannabis Industry
• California’s new AB 1159 provides that compliant commercial cannabis activity is a lawful object of a contract and increases the availability of attorney-client privilege
• Include escape clauses when non-compliant activity is occurring
• Build in audit rights to check on compliance?
39
Structuring Enforceable Contracts in the Cannabis Industry
• Emerging businesses face an industry specific problem: speculative damages in a new industry
• Liquidated damages clause?
• Arbitration: If there is any concern about enforceability because of lawful object of contract, insist on arbitration clauses in all contracts, including the arbitrator determining whether the dispute is subject to arbitration and whether the underlying contract is illegal, and confirm the arbitration award in Court just like any other judgment
40
Courts May Refuse to Enforce Cannabis-Related Contracts
Refusing to Enforce
- Tracy v. USAA Casualty Insurance Co., District of Hawaii, 2012, insurance
on medical cultivation facility
- Hemphill v. Liberty Mutual Insurance Company, District of New Mexico,
2013, insurance to cover medical expenses as applied to medical cannabis
- Staffin v. County of Shasta, United States District Court, Eastern District
of California, 2013, contracts to provide cannabis and lease a dispensary
and cultivation space under Contract Clause claim
41
Courts May Refuse to Enforce Cannabis-Related Contracts
Enforcing
- Green Cross Med., Inc. v. Gally, Arizona Court of Appeal, 2017, lease for medical dispensary - Green Earth Wellness Center, LLC v. Atain Specialty Insurance Co., District of Colorado, 2016, insurance for medical dispensary and cultivation operations- Mann v. Gullickson, Northern District of California, 2016, sale of cannabis consulting business
42
Leases: A contract of a different color
• When considering leases, make sure that your grower client negotiates out of the covenant not to use the space to violate laws
• Make sure the landlord knows what the tenant will be doing with the space• Beware of forfeiture laws
• Negotiate out of the law of fixtures: grow facilities require building in equipment, get clarity on whether the landlord gets to keep the lights, irrigation system, fans, etc.
• Live/Work Arrangements- resident farmers reluctant to leave, beware of the accidental tenancy
43
Will a Court Refuse to Decide?
- Enforcement of a contract to buy, sell, or process cannabis
- Enforcement of a contract sell all or part of a plant-touching business
- Enforcement of a typical business contract (e.g., insurance) as to a cannabis business
- Enforcement of a cannabis company’s debt other than for sale of cannabis products
- Damages from a cannabis company for torts or other violations
Greatest Risk
Lowest Risk
44
How to Mitigate the Risk of Non-
Enforcement: Create Options for Self-Help
45
How to Mitigate the Risk of Non-
Enforcement: Arbitration
Court Litigation Arbitration
Public Private
Busy Judge Concerned with Appearance of Involvement in Illegal Activity
Retired Judge or Lawyer Being Paid by the Hour
Lengthy, Expensive Process Sometimes More Efficient
More Likely to Have a Clear Winner More Likely to ”Split the Baby”
46
Special Issues for Cannabis Litigants
Mediation:
• Entirely voluntary
• Hard to find mediators willing and competent to resolve
cannabis disputes
• New Cannabis-focused ADR groups
• Mediation clause with teeth: mediate or no attorney’s fees
Arbitration:
• Draft contracts with comprehensive arbitration clauses
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