Controlling Habits Illegal contracts abound in the California cannabis space

For years now, many different cannabis business relationships across the industry spectrum have been analyzed. Altogether, there have been many different contractual and corporate set-ups within a variety of cannabis-friendly states. California, though, takes the cake on the most bizarre and legally questionable cannabis business relationships and contract structures, and that makes sense as California cannabis continues to emerge sort of slowly from a grey medical market. These arrangements either skirt the cannabis rules completely, or they make zero sense from a contract and/or corporate governance standpoint.

 

Unlicensed companies operating under another company’s license

Whether intentional or not, the Bureau of Cannabis Control (BCC) created a fairly confusing situation with the adoption of Rule 5032 where it mandates that all commercial cannabis activity can only occur between licensees. In its Final Statement of Reasons, the BCC also states that unlicensed parties can have white label and/or intellectual property (IP) licensing relationships with licensees so long as those unlicensed parties are disclosed to the BCC as a financial interest holder. Some parties have taken this a step further to interpret this rule to mean that an unlicensed company, so long as it’s disclosed to the BCC in some capacity, can literally operate its own business within/under/through a licensed company, conducting commercial cannabis activity as if the unlicensed company owns the license. Things become very confusing from a performance obligation perspective when one of these unlicensed companies is an equity owner in the licensed business, but is also acting as, let’s say, a management company of that licensed business at the same time.

These arrangements, of course, aggressively push boundaries and are untested with the BCC (let alone with local governments). Still, I’m seeing these proposed agreements between licensed and unlicensed parties more and more—unlicensed parties simply do not want to or cannot secure their own licenses, despite conducting all the regulated commercial cannabis activity.

 

Licensee contracts with unlicensed parties that operate at a licensed facility

These kinds of contracts become increasingly tricky because of the first example in this article. If you’re a licensee and you’re being presented with a contract from an unlicensed party that’s operating within another company’s licensed premises, you need to proceed with extreme caution. Even if an unlicensed company is disclosed under another licensee as an “owner” or a “financial interest holder,” that doesn’t mean that that company can start undertaking its own commercial cannabis activity carte blanche.

If you recall, commercial cannabis activity can only be conducted between licensees. That’s not to say that an unlicensed company cannot assist a licensee with its commercial cannabis activity, but if that unlicensed company is inking its own contracts without any mention of the actual licensee under which it operates, you’re going to have significant regulatory issues in the future (not to mention murky issues around representations and warranties around compliance with the rules, fitness of product, recalls, etc.).

“These arrangements either skirt the cannabis rules completely, or that make zero sense from a contract and/or corporate governance standpoint.”

 

IP licensing and white labeling

Thanks again to the BCC, IP licensing with cannabis licensees in California is not at all straightforward. While unlicensed companies can license their IP to cannabis licensees as long as those unlicensed companies are disclosed as financial interest holders, if they exercise too much direction, control and/or management over the licensee relative to the IP, the unlicensed company may be considered an “owner” under BCC regulations; and that means disclosure of the unlicensed party and maximum scrutiny from the state. Anyone who’s done an IP licensing agreement knows that the licensor typically gets substantial control over the use of the IP relative to the licensee, so already we potentially have a problem in California where preserving the integrity of the mark “too much” may make the licensor an “owner” of the cannabis licensee.

California cannabis has certain pitfalls that are unlike any other state due to the nascent nature of the licensed industry and ambiguities created by the regulators. Unfortunately, these pitfalls and ambiguities aren’t being addressed with additional guidance or even consistent BCC enforcement. In any event, proceed with caution out there, and be sure to read the fine print in your proposed agreements and in the rules.

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