A contract isn’t worth much without your being able to enforce it, and the same goes for commercial leases. We’ve written about unique problems in cannabis contracts due to the state-vs-federal illegality problem and of how courts have navigated that inconsistency in the context of contract enforcement. But when it comes to commercial cannabis leases in California, landlords and cannabis companies alike want to know how likely it is a court will enforce their lease. The short answer: it’s much likelier now than five years ago.
The main challenge with California commercial cannabis leases, as with all cannabis contracts, goes back to the problem of federal illegality. Because cannabis is still federally prohibited under the Federal Controlled Substances Act, it is federally illegal to cultivate, manufacture, or sell cannabis for any purpose. This means cannabis contracts trigger the doctrine of illegality in contract law, which holds that contracts without a lawful object are void and unenforceable as against public policy. Though enforcement of contracts is generally governed by state law, state law includes federal law under the U.S. Constitution’s Supremacy Clause.
Courts have struggled with how to reconcile the different laws, but a consistent theme emerges in California court decisions: commercial cannabis lease agreements will generally be enforced so long as the dispute before the court is purely contractual and so long as the landlord and tenant are in an arms-length transaction for payment of rent. One infamous example of this is the Harborside case, where a U.S. District Court declined to void a commercial lease for a cannabis dispensary on grounds of illegality, where the dispensary was in compliance with California law.
Another more recent example is Mann v. Gullickson, a November 2016 Northern District of California decision involving a dispute between a creditor plaintiff who sold shares in two cannabis businesses to the defendant in exchange for a promissory note. When the creditor sued for nonpayment under the promissory note, the defendant argued federal illegality rendered the contract (the promissory note) unenforceable. Though the court acknowledged it could void a contract if it required a party to violate the CSA by, for example, requiring it to cultivate or sell cannabis, for several reasons, the court declined to do so in this case.
First, the fact that the court could order payment on the note without requiring any cannabis-related actions meant that enforcing the contract would not necessarily further an illegal purpose. Second, even if an illegal purpose were to be furthered, the court found it would be inequitable for the defendant to be unjustly enriched by not having to pay on the promissory note. Third, the court noted that many states, including California, had recently changed their laws to encourage state-legal cannabis business activities, thereby undercutting the defendant’s public policy argument. Fourth, and most interestingly, the court called out the observed effect of changing state laws on federal enforcement: “The federal government’s concern over the CSA’s medical marijuana prohibition has waned in recent years, and the underlying policy purporting to support this prohibition has been undermined.” The court also noted that under the McIntosh case, the Rohrabacher-Farr amendment prohibits CSA enforcement against medical marijuana in the Ninth Circuit (the federal appellate circuit that encompasses California).
The lesson to be drawn from these cases for California commercial cannabis leases is that cannabis leases should be written to keep the landlord-tenant relationship as an arms-length transaction. This means no profit-sharing arrangements, no payments in cannabis product, and no equity shares changing hands; just payment of rent. Ultimately, the best way to avoid enforcement problems for your California commercial cannabis lease may be to include a well-drafted arbitration clause that specifies choice of California state law, among other things, as that can to a large extent side-step the issue of court enforcement, at least until you need to get your arbitration award enforced by a court.
To help you better understand what is going on with California cannabis and what MAUCRSA means for your cannabis business, three of our California attorneys will be hosting a free webinar on Tuesday August 8, 2017, from 12 pm to 1 pm PT. Hilary Bricken from our Los Angeles office will moderate two of our San Francisco-based attorneys (Alison Malsbury and Habib Bentelab) in a discussion on the major changes between the MCRSA and MAUCRSA, including on vertical integration and ownership of multiple licenses, revised distributorship standards, and what California cannabis license applicants can expect more generally from California’s Bureau of Cannabis Control as rule-making continues through the remainder of the year. They will also address questions from the audience both during and at the end of the webinar.