If you are one of those oppositional defiant types who wants to have a practice that is a federal crime, you may want to consider cannabis law. My practice is technically a federal conspiracy and other crimes not being enforced related to the cannabis industry. I’m not proud of it, and think our federal government must do better. Our firm is labeled a tier-2 Marijuana-Related Business (MRB) that provides business services to plant-touching tier-1 MRBs that either cultivate, process, traffic or ship cannabis pursuant to a license issued under state law. If you are weirded out that your cannabis law practice is a federal crime, at least the state that issued you the license to practice is an accomplice. What exactly does the practice of cannabis law entail? Answering that question is the subject matter of this article.
First, know that you are righting the wrongs of our racist past that hoodwinked science by literally rebranding cannabis as marijuana. The drug war has been a complete failure, with quasi-legal drugs killing tens of thousands of Americans a year. The opioids ravaging families in our great land trace themselves back to heroin, which rightfully remains a schedule I substance under the Controlled Substances Act (CSA) alongside a flower that was spelled ‘marihuana’ and changed to that to confuse scientists and people at large.
Cannabis had been used as medicine for decades, and the AMA advised against its criminality in 1937, as did the Shafer Commission that studied where to place “marihuana” under our current federal law in 1972. This is an ongoing injustice, and tens of thousands of Americans are being unfairly locked up. Meanwhile, other people from all over the country and beyond have turned cannabis into a legitimate industry worth billions of dollars and growing fast.
The social equity movement that has spread across the cannabis industry calls for those people with marijuana convictions, or those who have long-term residence in areas disproportionately injured by the drug war, to be ensured a seat at the table of legal cannabis. In some states, you cannot win a cannabis business license without social equity. In others, like New Jersey, they enjoy a highly favored priority and get awarded the licenses before any other applicants.
Every state approaches legalizing it differently. They act as the laboratories of democracy when it comes to their spin on the regulatory scheme for the licensing and sale of cannabis. Some states have open markets with low barriers to entry, while others have limited markets with only a few licenses and extremely burdensome regulations for security and even odor. As a result, the licenses themselves become an asset worth millions of dollars.
States like Illinois have only a few licenses. The financial cost of starting the smallest cultivation license in Illinois runs near $10 million, but only social equity applicants qualify for the license. This puts license holders in a bizarre position, because they have to sell equity to get financing to try to become operational. If anything goes wrong, the state may take back the license, or it could be sold to another entity for millions if the Department of Agriculture approves the sale. Unlike other states, Illinois has cannabis regulation spread across numerous administrative agencies instead of in a centralized cannabis regulatory department.
This intersection of the dual sovereignty issue and the fast-growing pace of the regulated cannabis industry is where the lion’s share of legal services and business consulting services are provided by professionals. Many of the CEOs in the industry are lawyers. The industry is highly regulated and resembles other highly regulated industries like banking or health care. As a result, general counsel are important members of the team in the highly regulated states. Those roles provide attorneys with an opportunity to get into the industry.
In limited market states, like Illinois or Florida, the practice concentrates on the many corporate issues of operating in a capital-intensive and highly regulated industry. To be effective, the practitioner needs knowledge of financial reports, corporate formalities and records like a company’s cap table. Additionally, familiarity with capital raising among privately held corporate entities is very important, because many of the companies are actively raising capital at any given time.
Other states have adopted more open markets without license caps, and with greater flexibility on how much capital the startup getting into the industry needs to have. In states like New Mexico or Maine, an entrepreneur can bootstrap into business with a single-member LLC and a few hundred thousand dollars or less in startup capital, and get operational in a matter of months. The applications in these states are more like a check-the-box regulation where you affirm your compliance with the rules.
The practice of cannabis law starts with the license application. The application process can be complex or straightforward. Some states adopt conditional licenses, with applications consisting of basic information about the applicant and their eligibility for either capital or social equity. Applicants are placed in a lottery for a license. After winning a conditional license, the new license holder has to gather all of its documentation and plans for its safety, security, cultivation, waste management, energy, diversity policies and anything else the regulators believe relevant to the license.
Other states require a complete and competitive application before issuing any license. These applications can range from tens to hundreds of pages, with details demonstrating the applicants’ compliance with any and all applicable regulations. Failure to provide for compliance with all the requirements results in an incomplete application that is rejected by the regulatory authorities for deficiencies that must be corrected before the applicant can move forward in the process.
This competitive application process to win a limited license is where many consultants make a good living. Cannabis can be completely alien territory for the outsiders trying to break into the industry. Lawyers with experience in gaming, or industries competing for grants or government contracts have a leg up in the battle to draft complete applications. Many applicants cannot fathom that their MBA is not enough for them to draft a business plan, but they fail to appreciate that the business plan the regulators require is far different from the one used to pitch investors or creditors.
Drafting these winning applications takes hundreds of hours and requires numerous consultants to assemble the scores of pages demonstrating the applicant’s compliance. In jurisdictions that use this type of application process, the application itself becomes a condition of the license, and anything the applicant puts in it to win the license must be carried out, or they risk non-compliance and may jeopardize the license they worked so hard to obtain. Many times, the states or municipalities that have this type of application use the complexity of the process to plug in the winners they want, whether politically connected, social equity or experienced operators.
In either open market or limited market states, litigation between the partners or vendors happens all the time. Both people that are only in it for the money and true believers comprise the industry operators. When you add high start-up costs and cash flows in the millions of dollars, litigation often results. Contractual agreements need to be crafted with an eye toward enforcing them in court in case anything goes wrong for your clients, because that will happen. The industry forces conflict with competing interests of greed, maximizing shareholder returns, and social equity. Combine all of this with tight license application windows and you see why many state systems fail to launch and produce massive litigation with dozens of parties stuck in court for years.
Intellectual property issues abound in the new industry. Many of the players cannot win a license in a new jurisdiction. Companies get into new markets using management agreements, licensing agreements and other contracts where brands can get their genetics, trademarks and products shelf space at your local cannabis dispensary. Genetics for the plants can be patented. However, federal law does not allow for cannabis trademarks. State law protection is available for the operators that are trying to start their brand in their home state before expanding into other states to become a multi-state operator (MSO).
Besides corporate, litigation, regulatory, and IP practice areas, a cannabis lawyer cannot adequately advise clients without some tax law knowledge of a peculiar sort. In 1980, a cocaine dealer got busted. One of his clever lawyers argued that he was entitled to deduct the cost of inventory, and expenses required to carry out his illegal cocaine trafficking. The tax court agreed and allowed thedeductions. Congress passed Section 280E of the Internal Revenue Code (IRC) soon after. IRC-280E creates burdens and risks faced by no other industry in the country. It forbids deducting ordinary and common expenses for trafficking any schedule I or II substance under the CSA.
Again, for no good reason at all, marihuana is a legal term of art defining cannabis as a schedule I substance. Because of this, cannabis dispensaries get audited by the IRS about 20 times more than any standard business. It impacts the tax elections of the entities and slashes the profitability of the industry. Despite all of this, the cannabis industry is expected to grow by about 30 percent this year. If you get into the industry, look me up. I’m not hard to find if you stay on top of cannabis legalization news.
About the Author:
Thomas Howard has been advising clients on cannabis business issues for over five years, from financial institutions to operating cannabis license holders. He helped draft winning applications in highly competitive rounds in Illinois and became a cannabis activist after researching the history of the cannabis laws at Marquette Law School. Email him at tom@collateralbase.com