For years now, I’ve seen and analyzed many alternative cannabis enterprise relationships throughout the trade spectrum. Particularly, many proposed and draft agreements have come throughout my desk detailing the contractual relationships between quite a lot of events within the cannabis trade for varied functions–from buyers, ancillary providers suppliers, and licensees to mental property holding firms, tools lessors, and lenders (and extra). Altogether, I’ve seen plenty of totally different contractual and company set ups inside quite a lot of cannabis-friendly states. California, although. takes the cake on essentially the most weird and legally questionable cannabis enterprise relationships and contract constructions; and that is smart as California cannabis continues to emerge (form of slowly) from a grey medical market.
Finally, if you consider California’s cannabis market at this level, you possibly can harken again to Rod Serling saying:
You’re shifting right into a land of each shadow and substance, of issues and concepts. You’ve simply crossed over into … the Twilight Zone.”
I lately wrote about all of the unhealthy conduct that also happens in California (even with licensing in play) and in addition in regards to the prime 5 most harmful cannabis contracts on this state, however this publish is devoted to these contractual and company relationships and constructions I’ve seen most lately within the Golden State that maintain developing repeatedly. These preparations both skirt the cannabis guidelines utterly, or make zero sense from a contract and/or company governance standpoint. So, in case you’re seeing these agreements and constructions within the market and scratching your head, you’re not alone.
1. Unlicensed firms working beneath one other firm’s license.
The variety of instances I’ve seen a licensee permit an unlicensed enterprise to function inside its premises is growing quickly in California. In most different states, the rules make abundantly clear that any firm engaged in industrial cannabis exercise, it doesn’t matter what, would require a cannabis license and that you simply can’t function an unlicensed cannabis enterprise throughout the licensed premises of one other firm. Not so right here in California.
Whether or not it meant to take action or not, the Bureau of Hashish Management (BCC) created a reasonably complicated state of affairs with the adoption of Rule 5032 the place it mandates that every one industrial cannabis exercise can solely happen between licensees however on the similar time. In its Ultimate Assertion of Causes, the BCC additionally states that unlicensed events can have white label and/or mental property (IP) licensing relationships with licensees as long as these unlicensed events are disclosed to the BCC as a monetary curiosity holder. Some events have taken this a step additional to interpret this rule to imply that an unlicensed firm, as long as it’s disclosed to the BCC in some capability, can actually function its personal enterprise inside/beneath/by means of a licensed firm, conducting industrial cannabis exercise as if the unlicensed firm owns the license. (And issues grow to be very complicated from a efficiency obligation perspective when certainly one of these unlicensed firms is an fairness proprietor within the licensed enterprise, however can be appearing as, let’s say, a administration firm of that licensed enterprise on the similar time).
These preparations, after all, aggressively push boundaries and are untested with the BCC (not to mention with native governments). Nonetheless, I’m seeing these proposed agreements between licensed and unlicensed events an increasing number of: unlicensed events merely don’t wish to or can’t safe their very own licenses, regardless of conducting all of the regulated industrial cannabis exercise. I’ve little doubt that after the BCC lastly flips into enforcement mode that it’s going to begin actually analyzing these relationships to find out who is definitely conducting industrial cannabis exercise in violation of the principles (most likely plenty of people).
2. Licensee contracts with unlicensed events that function at a licensed facility.
These sorts of contracts grow to be more and more difficult due to no 1 above. If you happen to’re a licensee and also you’re being offered with a contract from an unlicensed occasion that’s working inside one other firm’s licensed premises, it’s essential to proceed with excessive warning. Even when an unlicensed firm is disclosed beneath one other licensee as an “proprietor” or a “monetary curiosity holder,” that doesn’t imply that that firm can begin endeavor its personal industrial cannabis exercise carte blanche.
Recall, industrial cannabis exercise can solely be carried out between licensees. That’s to not say that an unlicensed firm can’t help a licensee with its industrial cannabis exercise, but when that unlicensed firm is inking its personal contracts with none point out of the particular licensee beneath which it operates, you’re going to have vital regulatory points sooner or later (to not point out murky points round representations and warranties round compliance with the principles, health of product, remembers, and many others.).
The frequent relationship I’m now seeing most frequently is the place an unlicensed firm is using a cultivation or manufacturing facility and attempting to instantly contract with licensed distributors or retailers to get their very own product to market (the place that product, on the similar time, will include the cultivator’s or producer’s info to fulfill the packaging and labeling guidelines, however will likely be co-branded with the unlicensed firm’s info and mental property). With out extra steerage from the BCC, it’s not tough to find out that such a contract violates Rule 5032.
3. IP licensing and white labeling.
Thanks once more to the BCC, IP licensing with cannabis licensees in California is under no circumstances simple. Whereas unlicensed firms can license their IP to cannabis licensees so long as these unlicensed firms are disclosed as monetary curiosity holders, in the event that they train an excessive amount of route, management, and/or administration over the licensee relative to the IP, the unlicensed firm could also be thought of an “proprietor” beneath BCC rules; and meaning disclosure of the unlicensed occasion and most scrutiny from the state.
Anybody who’s finished an IP licensing settlement is aware of that the licensor sometimes will get substantial management over using the IP relative to the licensee, so already we doubtlessly have an issue in California the place preserving the integrity of the mark “an excessive amount of” might make the licensor an “proprietor” of the cannabis licensee. The identical situation might happen with white labeling, the place an excessive amount of management over formulations and product compilation might quantity to illegal “possession” over the cannabis licensee.
I’m optimistic that there are IP licensing and white label and provide agreements in California which have created secret homeowners in all places due to the extent of management in these agreements given to unlicensed events. The BCC has little or no steerage out about these relationships, so its scrutiny of those agreements will most likely be on a case-by-case foundation if and when such relationships are found.
4. Disclosure points.
Close to as I can inform when speaking to people, most individuals nonetheless don’t perceive or know the extent of proprietor and monetary curiosity holder disclosures required by the State of California. What’s for positive, although, is that sure buyers and financiers wish to keep away from these points altogether in the event that they may also help it (which is less complicated mentioned than finished). Specifically with the BCC, in case you’re an proprietor that’s an entity, you might be disclosing each single proprietor in that entity, even when they personal beneath 20% of the entity. This implies you’ll disclose not solely your fairness homeowners at 20% or extra AND all people in a management, route, or administration positions, however you’ll additionally disclose your whole monetary curiosity holders (with only a few exceptions) which might be at 19% or much less in fairness. (And, sure, this contains disclosure of any funding funds or restricted companions in a basic partnership, and each individual or entity inside these constructions, too, in case you ask the BCC).
All of that is clearly extraordinarily problematic for fundraising and M&A and plenty of licensees don’t notice that they’ll violate the principles in the event that they fail to well timed make these disclosures. Regardless of that truth, I see plenty of transactions and cap tables from licensees the place they notice solely when it’s too late that they have to make these strong proprietor and monetary curiosity holder disclosures or face main rule violations. And plenty of of these funding agreements and/or M&A transactions don’t even point out any type of default or obligation round these disclosures — which is a large drafting mistake.
5. Working with out a provisional license.
For some cause, some stakeholders are beneath the impression that they will proceed to function if they’ve native authorization however no state license. That is simply lifeless incorrect. And even when you have native authorization and have utilized for an annual license so as to get a provisional license, you continue to can’t function. Simply standing in line for a provisional doesn’t make you a authorized operator. It’s a must to have each native authorization and both a provisional or annual license. In doing diligence on sure operators, I’m persevering with to see expired short-term licensees that don’t but have provisional or annual licenses. To patrons and/or buyers of cannabis firms in California, guarantee that your goal has each native authorization and a state license earlier than pulling the set off.
California cannabis has sure pitfalls which might be in contrast to some other state because of the nascent nature of the licensed trade and ambiguities created by the regulators. Sadly, these pitfalls and ambiguities aren’t being addressed with extra steerage and even constant BCC enforcement. In any occasion, proceed with warning on the market and be sure you learn the high-quality print in your proposed agreements and within the guidelines.