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The Cannabis Industry: Best Practices for Attorneys

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The Cannabis Industry: Best Practices for Attorneys

Looking to represent clients in the Cannabis Industry? This course will give participant a basic understanding of the most important issues facing cannabis businesses today, including the current interplay between state and federal law, permitting processes, real estate considerations and cannabis, corporate entity formation, taxation, buying and selling of cannabis businesses, residency requirements and the dormant commerce clause, bankruptcy and receivership laws, nuisance and RICO actions, and employment law and cannabis.

Transcript

Welcome. Hi, everyone. Welcome to the Cannabis Industry Best Practices for Attorneys. My name is Mike Ross. I'm an attorney here at the law firm of Prince Lobel. I'm a partner and co-chair of the cannabis group. And today I'm joined by another partner of Prince Lobel, Jim Landau. Want to say hi, Jim. Hi, everyone. As Mike said, I'm Jim Landau. I work out of the New York office of Prince Lobel and we all are working on intensely focused on cannabis related matters. All right. So we'll get right into it. We're excited to kind of go over all this information with you. Let's do it. Next slide, please. All right. So this is kind of a fun slide. A little mad scientist slide. But this right here pretty much gives you the entire industry in a nutshell. I'll walk you through it, and then we're going to kind of walk you through it more slowly with some of the specific information that hits on some of these functions. So you start at the Orange Circle and the first thing we tell people in the cannabis industry is that they should hire an attorney and where possible, they should consider Prince Lobel. And from there, we recommend that companies form an entity. Now we're going to talk a little bit more about entity formation, but the the type of entity you form and for what aspect of the business, whether it's the cannabis side or the real estate side, and how that entity is formed in terms of the type of corporation. If it's a stacked corporation with an LLC, those are all considerations that a corporate level attorney should really be working on. And they all have different implications. They all have different tax implications and it's fairly extensive entity formation gets into also who is the business group? Who are the investors? What does the operating agreement look like? Who owns what if? As you shift over to investors, I had this little hash mark on the edges of that and and social equity. We do that because sometimes certain states, certain municipalities have requirements that the applicants be composed of a certain percentage of a certain type of individual, a social equity applicant, a previously criminally involved within the failed war on drugs, so-called war on drugs, as New York has applicant where 51% of the. Entity had been arrested, convicted for a cannabis crime. So the entity formation might might bleed into, will bleed into your licensing regime, into your, um, into how you're actually entitled to proceed within the municipality, within the state. And so all of that, it's corporate. Yes, but it's also your cannabis attorney or your cannabis team helping to, to guide that process, to make sure it complies with the percentage of. Ownership that's necessary. Site control where that is the really the the question. Where are you going to be that drives everything? Is there another entity within a certain distance from you that you're prohibited from citing your location at Because there are buffer zones in that particular particular state and that particular municipality. Are you near a school where there might be a buffer zone? Are you allowed to overcome those buffer zones through a zoning variance or through some other means? Are you properly zoned or are you in a residential area and are you allowed to overcome those use prohibitions with a variance through a zoning process? These are all things that you'll consider. Then once you have that site control where you want to be. How do you secure that property? Do you do it through a letter of intent, a binding letter of intent, a non-binding letter of intent, a lease? Are you cognizant of the business terms? Because yeah, we're lawyers, but can your client make it to the end of this maze while still holding? Complicated business terms hold fees that might be too expensive, prohibitive for them to proceed. Those are all business terms, but they are also rolled into your letter of intent, your lease prior to. Um, you opening your doors, make sure there is a contingency, a permanent contingency that allows you to open your doors. Otherwise, you'll be stuck with a facility. And again, what we see in states there's a lot of. Dollar signs in the eyes of landlords. When the cannabis industry first opens. But slowly those numbers come down to reality very quickly, and you need to make sure that you can. Your business will be able to survive. Your client's business will be able to survive. Could you become the landlord of the property? Ideally, that would be great. You can control a lot of things when you do that, but you would want to again form a different entity. You would want to be separated from the cannabis entity for a number of reasons, for tax reasons, but also for cannabis touching reasons. If you are a. Landlord that's not touching cannabis. That will have a different tax treatment consequence than if, say, you're the same entity and you're owning the facility. The. Another thing that you need to look at is who owns the note on this property? Is it a. A federal bank, that federally insured bank that has no interest in getting involved in cannabis. Cannabis is an illegal schedule one substance. It's up there with cocaine and heroin. Right now, you know, there's talk of of rescheduling it. Will your bank allow will your landlords bank allow the cannabis entity to be a tenant in that building if they have a mortgage? What do you do if that bank if you're the cannabis entity, you've gone through hundreds of thousands of dollars to get to your doors, opening maybe $1 million in some cases, maybe more if you're a grow facility, close to $10 million. What what do you do if the bank calls the note the day before you're ready to open or the day after you open? Are there provisions in that lease that allow you to step in through investors or other means or other banks or other debt instruments in order to take the landlord out or take the bank out or the the mortgage or out of that circle? So we could go on and on. But there are terms about getting into a you know, can your landlord walk into typically a landlord is allowed to walk on to the premises with notice. Well, in the cannabis world, your landlord is not allowed to walk onto your premises without having proper authorization through the city, through the state. However that works, those provisions need to be in the leases. We mentioned social equity. That's a big part of the industry. It's essential that you understand that the long. War battle on cannabis in the United States and what it's meant for. Imprisoning mostly communities of color and how there is an effort to. To right the wrongs of the past by allowing this industry to be open to those who were. Disproportionately policed. Uh, so local cannabis board. So now you're getting into the municipal approvals. You know, often there's a licensing type board or there's a zoning type board or both, often at the local municipal level. And really what we found is and that's not everywhere, of course, right, because there's different types of licenses. Um, but really it's, you know, all politics is local. All, all, um, you know, all politics with cannabis are local to the where is again controls this. So while there might be in certain jurisdictions a strong state regime. You still need to cite these at the local levels and there might be very strong language at the state regime saying that a local municipality needs to treat this exactly like alcohol and can't discriminate against the fact that the use is cannabis. Well, that's one thing to say that. It's another thing to put that into practice. And while you have your lawyers, these decisions are much better when you don't have to spend a year or two in court when you can just get through. So there's a lot to consider at the local municipal level. We spent a lot of time on it. Some of it has been commoditized in terms of non-lawyers working in this space. I guess it depends where you are. You might also want to consider in this space, do you hire the local person in that town who knows the zoning and the mayor and the select board and all those people? Or do you come out from the, you know, the major city near that municipality? These are all considerations. When you're assembling a team, it's usually going to be more than just one lawyer. Sometimes one lawyer can do this all, but it would have to be one multi-talented lawyer. You need to start to think about insurance for your client. Not everyone insures this industry. There are there are many insurance companies now that do. If you get stuck, feel free to reach out. We can give you some names. Well, now it's time to open your door to commence operations. And hopefully you've made it to this point. That's a great feeling. But even then, when you start to look at the numbers, are you even making money as a legitimate question at this point? Once you pay back all your debt and all your obligations and then realize the tax consequences are what is your break even, and then how do you get out of it? Are you going to just stay open forever? Do you sell it? Do you merge with a larger entity that your corporate attorney comes back here? You very valuable working also with brokers, business brokers, industry. You might want to start attending certain functions and forum where you can talk to people who might be interested in buying your entity. Um, so, you know, so I mentioned that the schedule one situation with cannabis there is now an effort to reschedule cannabis. There's a lot to consider there. It's generally good news for sure. But the question is, how does what does that look like? How does that show up on the ground, you know, And what role will the federal government now take in allowing for a medical schedule three cannabis? And what does that mean for non-medical cannabis and what will that require in terms of the process for getting your medical licenses when it's now federally controlled? But schedule three substance like other pharmaceutical medicines, etcetera? A lot happening in this space right now, Jim. I don't know if there's anything you want to add on that. Yeah. Let me just say a couple of things right now, just to go back to the basics. Marijuana is still listed on Schedule one of the Controlled Substances Act, which is a federal law that was passed during the Nixon administration and that's a drug, a Schedule One drug is a drugs that are defined as drugs with no currently accepted medical use and a high potential for abuse. And marijuana is up there with heroin, LSD, ecstasy, meth and peyote and or Quaaludes and peyote. And you can see on the slide that, like cocaine or meth, are scheduled two drugs. And there's been what Mike was referring to was a proposal from the Department of Health who, you know, HHS to the DEA to reschedule marijuana from schedule one to schedule three. That hasn't happened yet. A schedule three drug is like Tylenol with codeine, and you need a prescription for that, but you can at least study it. And as long as you have a prescription and, you know, perhaps the federal government will take other steps, it'll be legal, which has all kinds of impact all across some of which we'll get into today. Next slide, Jen. We're stay in federal federal law. So I think I think Jim covered that. Yeah, I think we got it. Okay. Yeah. So, I. Mean, we focus. I mean, I'm in Massachusetts. Jim's in New York. We have colleagues who are in Connecticut and who practice in the other New England states. But we do practice all over the country. But often we showcase what's happening in Northeast. And I mean, just quick run through Massachusetts is fairly built out. I would say it's a mature market. Maine. We'll talk about the dormant commerce clause in a bit. Try to restrict it only to Maine residents that didn't work Needs to be open to the entire. A world or the United States anyways. Vermont has a has a market. New Hampshire does not. Connecticut began with a lottery system and has. A non lottery system as well. Rhode Island haven't checked in on Rhode Island a bit, but I believe they have a lottery. And then New York just announced its Non-card license program card being the justice involved conditional adult use retail dispensaries. Those were. Early this year were opened to justice involved individuals. It's now allowed into the. Took four for everyone. One thing that's really interesting and frankly kind of frustrating with the New York license is that if you have cultivation anywhere else in the world, any form of cultivation, any ownership of cultivation, if you are a true party, a person, a true party interest. Sorry, am I saying that right, Jim? Yeah, True party interest. You cannot participate in retail. So just to say again, if you have any kind of grow supply cultivation, side ownership outside of New York or certainly inside New York, you can't participate in retail inside New York. Real pain in the neck. But that is the New York rule and we're working through it. Next slide. And so here's just the United States is snapshot, I guess I'd say this. Look at the orange states. There are four of them. Subtract that from 50. That means that leaves 46. That means that there are 46 states plus Puerto Rico with something that has to do with legal marijuana. So that is quite a statement. More than half the United States have some form. It looks like there are 24 that are fully legal. We might need to look at that number. I don't know how if anything's changed since then. When we put this slide together, September 1st 23, it's probably probably accurate. Um, but yeah, I mean, pretty much the United States, the whole United States has some form of decriminalized legal, fully legal, CBD, even THC. There are. You know, so so the so the country is open for business unequivocally. And I would suspect that those ports that those four states will eventually flip to at least some of them. Uh, next slide. So there's different permanent processes. I mentioned this earlier. I mean, the lottery system is really difficult. You throw a lot of money at something and maybe you get picked and maybe you don't. You also can. The lottery system tends to favor the more sophisticated applicants who can create multiple entities and LLCs, pay multiple application fees and afford to throw in dozens of applications in order to game the system. Um, the competitive scoring system. Is very subjective. Very hard to. But to control in a political environment and can be very difficult. Caps. No caps. Using the market system is probably the preferred way to go with perhaps a social equity component where, say, half of the applicants are allowed to get maybe a a jump on the market. So that's what we're seeing a lot of in in more modern regimes. And then there's always going to be two types of regimes. There's going to be the state regime and the local municipality regime, and then the local we'll deal with the permitting. Like I said before, the licensing, the zoning, that type of stuff, the state you're going to be dealing with. Getting your actual. Approval your license, your more. In many ways it's more of a binary you either get or don't get the license from the state based on what you may or may not have at the local level. So do you have site control? Do you have approval by the municipality? Those are questions that the state will usually ask. So these two work hand in hand. The legacy market at the bottom is more of an issue in just New York City. I mean, I'm sure there's other cities that have some form of a legacy market, but New York City has a mature legacy market. I mean, I shouldn't explain this with Jim on the call, but because he he is a New Yorker and I'm not but just in a nutshell, for for decades, New York City, if you needed pot, you picked up a phone and someone brought it to you. That market has been in place for for decades and it's now extremely mature and sophisticated. And the question is, how do you put the genie back in the bottle to legalize that market? And at the same time, you have people taking advantage of the fact that there was this existing market and they're jumping in with an illegal market and what's being called a gray market. It's pretty, pretty nasty stuff. Jim, anything to add to that? Yeah. Um, so I'm sure people who will be watching this know because it's it's been widely publicized that there are thousands of illegal, unlicensed dispensaries in New York City, and many of those are not people from the legacy market. If you define the legacy market as as people in that market do, which is people who have been in the cannabis industry for up to five years before the passage of the Mrta, which was in 2021. And those are the people Mike was referencing that have kind of been keeping the industry going under the war on on drugs or the war on people. And so and in New York City, we're sitting on, uh, probably the largest demand market, consumer market for cannabis in the world. And people in the legacy market haven't been licensed, haven't been paying taxes, are able to get high quality product from all over the world, which gives them all distinct advantages to people in the legal market. And as we slowly in New York start licensing dispensaries that are going to have to compete with that, we have to kind of existential threats to the success of the legalized market. One is all of these dispensaries that are unlicensed, that have proliferated in the time that has elapsed between the passage of the M.T.A. And now, which is two and a half years and and how to enforce that in a environment that's really doesn't have a great appetite for enforcement. So how do we enforce the law and close those? And then the other issue is how do we provide a pathway, as Mike said, to people in the legacy market, to make it easy for easier for them to get a license so that they can then be competing on the same playing field as other license holders and, you know, compete more fairly. All right. Thanks, Jeff. Next slide. So we talked a little about real estate. Let's see what this has. Next slide. So, yeah, we talked about how a landlord could. You know what a perfect situation is, is a building that's fully owned by that landlord outright. I mean, that that's ideal. Put a mortgage in there. You just added a question mark to your client's business model. Um, again, if you do have a mortgage, you might want to take a look at the note that your landlord has. You might want language. You definitely want language in there. If the note is called, um, perhaps your landlord would be willing to switch to a more friendly or a friendly cannabis bank. Um. You know, you also have to consider things like access. Most of these regimes, all of them probably require accessible entrances for patients and customers to the facility. And so old buildings that are owned outright that don't have elevators, etcetera, You know, putting in an elevator for a retail dispensary is an expense you probably don't want to have your client have to pay for. And you certainly don't want to be on the hook of having to have failed to look at look at that when you go through these these these steps. And. We've talked about the access of the landlord. They can't just walk in. They have to be approved by the state or the local municipality to be able to walk in if that's ever something that you would allow. And then percentage rent. What happens if your landlord gets a certain percentage of the profits of the. Facility that's very common in retail settings like a coffee shop that might allow a certain percentage to the landlord. That's a big issue in New York, Mike. If a landlord gets percentage rent above a certain amount per year, they can become a true party in interest in the the tenant and it may eject the landlord to financial disclosures and other things. Yeah, you might. You might have to get your landlord to show up and get fingerprinted like everyone else in the in the entity and be, you know, we're running running the facility. So that's probably not something that your landlord wants to do. But maybe, maybe so. But it's all something you got to consider. Next slide. Securing real estate ownership. Obtaining bank financing. Well, yeah. So we've talked about the difficulty, although I will say that there are banks out there now that are absolutely playing in this in this space. We just heard from Needham Bank the other day that came and joined our lawyers for a conference, and they're extremely confident that they are fully compliant with federal law and have cracked the code there. And then there's other debt. Entities that would that support the industry as well. Um, lot of, lot of lot of banking occurring today. That didn't occur when we first began practicing in this space back in 2014. And now now would probably be a good time, Mike, to talk a little bit about the Safe Banking Act, which is legislation that's been pending in Congress seems like forever, at least a decade. And it is has never been closer to being passed than it has been. Now, that doesn't mean it's going to be passed tomorrow, but it's passed the House, I think, six times and just recently got through the Senate Banking Committee, Banking and Finance Committee for the first time almost ever. So it'll be interesting to see if the Safe Banking Act passes. That should go a long way towards bringing other banks into the fold and making them available to provide for mortgages and things. There you go. So land use zoning mean this is the bread and butter of our real estate industry of what we do as lawyers. You know, knowing whether or not those buffer zones, proximity to residential district, you might not even be in a residential district, but there might be a, you know, which most most I think of the cannabis industry is not in allowed in residential districts, although with a variance. You could be, but you might not even you won't even you might not even be in a residential district. You'd be in a commercial district, but you might have a proximity to buffer. Must not be within 1000ft of a residential zoned district. That makes it awfully hard in certain municipalities to cite these locations. But, you know. The municipality can't just say no to cannabis by. Uh. Outlawing through zoning, through draconian zoning methods by preventing you from opening in Massachusetts, the municipality that voted yes on the, uh, on cannabis in the in the initial ballot. Any municipality voted yes must have no fewer than 20% of the number of liquor license, liquor stores, package stores, liquor stores that that they have in their municipality. So if a municipality has 100 liquor stores, there must be no fewer than 20 cannabis dispensaries. If the zoning conspires to prevent 20 from being sited because of these many buffer zones like Boston has a half mile buffer zone, you cannot be within a half mile of another dispensary. If you can't get to that 20%. You as a lawyer need to step in, explain to the municipality that they are wrong, that they either provide you, I mean, maybe a variance, if you even want a variance, or that they remove those that that rule from the books. And again, you don't want to buy your client a lawsuit, but you need to protect your client in these spaces. Business considerations in canvas. Let's see what we got here. Uh, 280. So. Today while we're a schedule one and not schedule three, but a schedule one, we can not be legally. Operating within the eyes of the federal government. And so therefore, we fall under 280 of the tax code, which does not allow us to. Take the same deductions that a legal business does. So things like your employees are not allowed to be deducted from the cost of your business. The only thing you can deduct is. The only thing that you can deduct from your business is the cost of goods sold. So if you you know, if you bought $5 million worth of cannabis from a cultivator and then you sold it for $10 million, you can deduct the $5 million. But everything else, your rent, your employees, your electric bill, all that stuff that cannot be deducted. Now, that's more in a retail setting that's going to hurt you more than, say, in a cultivation of gross setting. A gross setting, you have a little bit more flexibility on what constitutes the cost of goods sold, some of the actual grow. And equipment, etcetera, can be can be included in there. So interestingly, for that reason, in states that allow vertical integration, i.e. allow both a grow facility and a retail facility, i.e. not New York, but everywhere else in those states, a lot of times what you see happening is the. The the cultivate the company shifting its resources to the cultivation, shifting its its cost centers to cultivation because there's more generous tax rules there and and operating at a loss in their retail because there's almost nothing that they can deduct just to get around this tax code to 80 is going to change when either the Safe Banking Act or the rescheduling or both occur at the federal level. But it will not change until that time. There are states, however, interestingly enough, that have removed their version of 280 from the fold so that you can make all those deductions. So at least at the state level, you're not getting killed. But at the federal level, this tax issue is preventing the industry from seeing real money. I guess in a nutshell, yeah. I just wanted to add a couple of things. The first thing is, is Mike's absolutely right that this is has a huge impact, particularly on dispensaries, because if you add the loss deductions on to the effective tax rate of the state, you can have a dispensary in California that may have an effective tax rate of up to 70%. It's really hard to make money. Don't know what the margins are on on their sales, but it's really hard for a dispensary to make money when you're giving up to 70% of your income away to state and federal taxes. The other thing I wanted to say is, yes, the interplay with banks is really important here because you have a situation where you you have don't have a lot of banking and you have unbearably high tax treatment for dispensaries in particular. And so you can see where the incentive would be very much to underreport one's income if you're a dispensary. And so that's not in the government's interest either. So so these are all kind of important considerations to think about as we're we're discussing these issues. No. All right. So, I mean, I'm not going to go too far down this road, but basically, this is where your corporate attorneys are going to be very helpful and your accountants, but mostly your corporate attorneys. You could actually tax yourself into oblivion if you do this wrong. So you have to be really careful. If you just took a straight LLC and had and decided to open your business, you would lose more money than you would actually gain just because of the tax issues. What we recommend is that or and likewise, if you were just a straight corporation, you would also. You would have substantial issues, just reality issues. You would not really make any money. What we and there are there are exceptions to this and there's always an exception to everything. And it's hard to say always what you should do. But but generally what we recommend is some sort of corporation over an LLC. So the LLC becomes a holding company and then below it you have. A corporation that. Um, traps any kind of income from hitting the investor group until such time as a distribution is made. We can show you this on the next slide. It's a little mind numbing. So this would be if you were just an LLC and you were charged at the full 37% federal tax rate. You can see actually you made $10 Million in in revenue, but you go all the way to the bottom. You actually lost $650,000. And this happens with a certain assumptions, etcetera. But you would actually lose money if you just opened as an LLC and and didn't didn't put the appropriate protections in place. Go to the next slide. You'll see that if you create an LLC with a C corp, you can actually make some form of money depending on your distributions to your shareholders. Um. You know, again, this is really depends on a lot of stuff. But your effective tax rates down below, you can see I mean in this case they're in the. 80s and 90s. I mean, it's very hard to make money in this industry right now and. You know, right now it's with two. You really you really, you know, you'll make money maybe if you sell the the industry or if you if you if you own maybe like I said, the, you know, different like a cultivation and retail and different ways of structuring it maybe through your real estate you can make a little bit more money too. That's one way to do this if you own the real estate and you operate. Really at no income for your retail, but you have a high, high rent that you charge yourself. Right. I mean, these these might be ways to make a little bit more in the industry, but it's very hard to do this today. And there are plenty of, you know, cannabis entities make money. But, you know, a lot of that has to do with more of a speculative with an eye towards the future. Right. So so a lot of a lot of mergers, acquisitions and other more kind of optimistic future which one day we know that the 280 tax issue is going to go away. We just don't know when that's going to happen. Next slide. So it's just like what I just said. It's just kind of over. Basically, you want to create an LLC with a C Corp and to protect your your shareholders. Because what happens is if you don't have this intervening entity, you're even if there's no distribution to your shareholders to to the ownership, they could be taxed on $10 million worth of or $5 million worth of product, even though they received nothing unless there's some sort of stacked LLC. C Corp to protect the protect the investor from phantom income. Uh, and then just probably my last slide. I think you're gonna hear more from Jim now. Is that, you know, how do you get out of this? What are the what are the end points for for businesses? Again, your your corporate attorney would would swoop in here. When you wind up selling, how are you selling your entity? You know, is it an asset purchase where you're selling your individual, uh, retail cultivation facilities and therefore have to really go back through the entire permitting process and look at, you know, gee, does my zoning, my planning docs, my licensing docs, are they unique for this applicant only or do I, you know, can I just step into the shoes of, you know, what are the what are the rights of, of the of the new entity or am I buying a stock purchase? Am I just buying the entity, the LLC and C Corp and buying 100% of that entity or a portion of that entity and not changing a thing in the eyes of the regulators, But even doing that, is there still language in the regulatory. Entities. That still requires me to come in even though it's just a stock purchase. There often is. So, you know, selling the businesses triggers really the entire life cycle of the legal permitting regime all over again. You need to look at all of that through your due diligence period. To make sure that you're able to open and continue to run and operate and step into the shoes of the of the. Operator. You know, there's there's no bankruptcy. I think we'll maybe talk about a little bit later in this industry. Um, so restructuring, getting out of your entities, selling it to a distressed asset, bringing in chief restructuring officers, all of that are ways out. But, you know, other than that. If you're losing money in the industry, there's not a bankruptcy federal bankruptcy available. Obviously, for the reasons we've discussed. And so in many cases, this might be either continuing to operate and wait for better days or mergers, acquisitions. Are are your ways out for the industry? I'll pause there and turn it back over to Jim to take us through the back half of this. Uh, thanks, Mike. Yeah, And I think it's important that we went through all of the stuff that you just discussed, because that is the kind of meat and potatoes of cannabis business. What we're going to turn next is to some various matters that have been litigated throughout the the US relating to cannabis. We're going to talk about residency requirements, the dormant commerce clause. We're going to talk about bankruptcy, as as Mike alluded to. Uh, employment cases, nuisance cases and the cases under Rico, the Racketeer Influenced and Corrupt Organizations Act. So let's start with residency requirements in cannabis and why they're important. So these are terms that obviously relate to what types of people are able to get licenses and other treatment from states when we're talking about cannabis. There are some strict requirements, some states with strict requirements which require applicants for cannabis licenses to be owned in whole or in part by in-state residents. As we'll see with Maine, they tried that soft requirements are where they're doing it a little bit more subtly and they're scoring people higher who reside in in a state as opposed to out of state people. And why do we focus on this? And that's because we're they're trying to focus on. Social reparation for in part for the harms that occurred in their state during the war on drugs. Or again, as as people are calling it, the war on people with overenforcement against particular. Folks, people of color, and they are very people are very focused on their own states because, again, it is federally illegal and it has been left to the states to develop these these industries. And so what happens is, is they they try to favor people in those in their communities, in their local communities, within their states who have suffered these harms. Um, the problem as we'll see is that it's, it's unconstitutional if you go too far. So in Maine, the the state's adult use law required that an applicant for a state license be a resident. And if it was a company that every officer had be a resident and that the majority of the shares be held by Maine residents or businesses. So this is a template for strict residency requirement. And although the state didn't enforce it, the city decided to then score a higher make a higher score. If you were at least 51% owned by Maine residents, they had a state requirement and guess the city took it very seriously and they did. A soft requirement of Portland, Maine, and New York has tried to be purposely vague in this area. You need a substantial connection, uh, that's usually satisfied by just having the entity that holds the license incorporate New York, but they're not really looking too carefully at where people are from. So these are these are this is problematic, as we have alluded to. Uh. Because of the dormant commerce clause, which is a doctrine of constitutional jurisprudence that precludes economic protectionism between the states. And so let's start with the Commerce Clause, because the dormant commerce clause is kind of the flip side, the underside of the commerce clause. And that we all know as lawyers the Commerce Clause empowers Congress to regulate commerce among the several states. And what the dormant Commerce clause prohibits is protectionist state regulation that's designed to benefit in-state economic interests by burdening out-of-state competitors. It is found that if you are if you have states that are protecting their own residents over people from outside, that that that definitely inhibits Congress's ability to regulate commerce among the several states. And you can see that this is the main case where a plaintiff alleged that the the law. Was unfair, was unconstitutional. It discriminated on its face against interstate commerce involving a scoring matrix that was used by regulators. This is the soft restriction that the city of Portland did. Interestingly, the city argued that the Controlled Substances Act by criminalizing cannabis implicitly granted the states the power to burden interstate commerce. So the city took the position that they were in fact, they were admitting that they were burdening interstate commerce, but they said they had a right to do it because of the Controlled Substances Act and that was soundly rejected. And the the motion for a stay against the matrix was granted. And here's another case in Missouri. Again, this was a situation where the ownership group had was a multi-state operator and it had vertical licenses in Pennsylvania and Missouri. Vertical licenses are basically licenses that enable you to do everything from seed, you know, growing through manufacturing and retail. Because plaintiff was a Pennsylvania resident, he was restricted in Missouri to holding a minority interest. And he argued that the 51% in state ownership requirement unfairly discriminated against him and other non Missouri residents in violation of the dormant commerce clause, and the district court agreed with him. And then there's a case in California. It cetera relating to this. And this is interesting only because it's it's saying that. In statute, state statutes that are not facially discriminatory. In other words, if it's not obvious that they're putting an undue restriction on out of state residents, they may still violate the dormant commerce clause if they discriminate in their practical effect. So they go further than just looking at the face of the statute. And they they look at what the impacts are. All right, let's go to bankruptcy and cannabis. And this is going to be an easy one for the person speaking to speak about because as Mike said, you you cannot. Bankruptcy is a creature of federal law. And so there's a litany of cases which we don't have to go through that all say pretty much the same thing, that if you are operating a cannabis business or really any business in violation of federal law, bankruptcy protection is not available to you. That means you can't force a trustee to administer an estate of a failed cannabis business and you're not going to be allowed to reorganize under the bankruptcy code because the courts are universally finding that the income that would form the basis for the reorganization is derived from illegal activity, even if it's illegal under state law. This is obviously a huge problem. If you as Mike alluded to, you can't you know, you have this high these high tax rates. You have low margin for making a profit. And if you fail, you don't have a bankruptcy statute to federal bankruptcy statute to rely upon. You know, it's interesting also in terms of the way this is all put together and attracting investment. You can't put your license up as collateral for investment because in most states, I think in all states, it's deemed to be a state owned license that's being granted. And states will not want to relinquish control over that license to just anyone. They need to be able to approve it. And so, you know, if you as a, let's say, a cannabis business, want to borrow money and you don't have many assets, say you're a dispensary and what you have is your accounts receivable. You don't have a ton of equipment. You may have some product. But but outside of that, the most valuable thing you have is the license. You can't put that up because the if you default default and you lose that license, it can't go into the hands of the creditor because the state hasn't approved it. And that is a big, I think, drag on being able to attract investment. And so these are these are these slides really deal with a bunch of cases which we're not going to go through at all. It basically already summarized it, but they pretty much say you don't get to go to bankruptcy court if you are out of business and you're operating a cannabis business because it's violative of federal law. And one of the cases that we should warn folks about, I'm not sure which one it is here, but I'll just describe it, is there was a bankruptcy of a employee. Who worked in a cannabis retail company owned none of it. And was not allowed to declare bankruptcy due to the fact that his income came from a legal cannabis company that he had no ownership of. And that is one of the more extreme cases in the industry. So bankruptcy, you know, this whole federal illegality schedule, one is is a very is a very complicating and telltale factor that we as attorneys need to be aware of and talk about. To our clients and not just say that the cannabis industry is legal, but warn our clients in our engagement letters, but in our day to day operations that there are some very serious ramifications that they will want to consider before they go forward. And being a part of the quote unquote, legal but federally illegal industry. Yeah, that's a very important point. We're very focused on licence holders, but employees of licence holders are going to get money from a business that's operating in violation of federal law. So they're going to not have bankruptcy protection available to them also. So yeah, very important point. Okay. So so what alternatives are there to bankruptcy in the cannabis industry? And you can you can see that Mike already kind of alluded to workouts. There are assignments for benefit of creditors. These are all kind of ways of doing bankruptcy without filing for bankruptcy. As long as creditors are cooperative. And frankly, creditors really don't have much choice but to be cooperative. If there's no, you know, ability to seize anything of value upon a default. And, you know, a lot of states have now come up with very elaborate receivership statutes, which, you know, and particularly out west, they they have kind of a process that that if not mimicking is very similar or parallel to federal bankruptcy law where you can submit receiver gets appointed, you know, the usually at the behest of the creditor but sometimes on behest the debtor and you have proofs of claim that get put in by creditors which will then be adjudicated by the receiver and the receiver would be, you know, responsible for protecting both the creditors and the debtor and maximizing value, etcetera, in a bad situation. All right, Let's go to nuisance quickly as we're running out of time. Uh, so nuisance claims are usually involving odor. They're often, you know, the wafting of the terpenes from the the marijuana. Usually in a grow scenario. And neighbor neighbors don't like it. These are often paired with Rico cases, which we'll talk about briefly as well. Uh, and uh, there are there are cases based on public nuisance basis, cases based on private nuisance. Uh, public nuisance is an unreasonable interference with the right comments of the general public and a private nuisance is a non trespassory invasion of another's interest in the private use and enjoyment of land. Uh, and you know, those are, there are a number of cases that that have bounced up, uh, over the, over the course of the, across the country over the course of many months and years of this, where the nuisance cases have been brought against cannabis businesses by neighbors. Uh, the second hand smoker rights have increased over the years, as you can see from the slide. Uh, and you can you can see that they're, they're banned in many localities and in many states, non hospitality workplaces, restaurants, bars, gambling facilities, college and university campuses. In New York, we're going to be having an site consumption lounge option, which will be very interesting. They're not doing licensing for that yet. And that's supposed to be, I guess, like a cigar bar. Um, and I'm sure there'll be those will be heavily regulated and to make sure that, uh, nobody, you know, second hand smoke is limited, limited, and also the terpenes smell is limited. Okay. We'll just hit Rico quickly. That's the Racketeer Influenced and Corrupt Organizations Act. It's a pretty complicated statute. It was originally designed to fight organized crime. There's a civil component to it that plaintiffs have been using for years and years that, you know, usually gets dismissed because the burdens of proof are very, very difficult and high. But you can go through the elements here and see the predicate act here is is easy as long as that that part of it is easy, as long as cannabis remains or marijuana remains illegal under the Controlled Substances Act. Schedule one drug and. Um. You know what? They're they're common. They're growing and and they're they're hard to win. And you can see these are some examples of cannabis cases. And let's just talk briefly about employment law and cannabis. This is kind of interesting. Talk about a case in Connecticut. Ms.. Nofsinger was a employee at a. An assisted living facility in Connecticut. She got an offer to go work at another one. She was a vet and or is a vet and suffers from post traumatic stress syndrome. And she is a medical marijuana patient in Connecticut. Took capsules overnight with THC to help her with her. Ptsd didn't impact her job. Make a long story short, she was told by the new employer that she'd be drug tested. She said, okay. She disclosed her marijuana use. They said no problem. And she failed a drug test. They rescinded the offer and she lost her job with the prior employer because she had given notice and she ultimately sued. And the court there found that she was wrongfully the offer was wrongfully rescinded because it was discriminatory, violated the anti-discrimination clause in Connecticut's medical marijuana law. And with that, I think we're out of time. So thank you for all for coming, Mike, and I really appreciate it. The opportunity to speak and take care. Thank you, everyone. We appreciate it. And if you have any questions, please feel free to reach out to us. We're happy to help our fellow travelers. Thank you.

Presenter(s)

JL
James Landau
Partner
Prince Lobel LLP
MRJ
Michael Ross, JD
Partner and Co-Chair
Prince Lobel LLP

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