The Regulatory Twilight Zone: California Hashish Transactions
For years now, I’ve seen and analyzed many alternative hashish enterprise relationships throughout the trade spectrum. Particularly, many proposed and draft agreements have come throughout my desk detailing the contractual relationships between a wide range of events within the hashish trade for varied functions–from buyers, ancillary companies suppliers, and licensees to mental property holding firms, tools lessors, and lenders (and extra). Altogether, I’ve seen numerous totally different contractual and company set ups inside a wide range of cannabis-friendly states. California, although. takes the cake on essentially the most weird and legally questionable hashish enterprise relationships and contract constructions; and that is smart as California hashish continues to emerge (kind of slowly) from a grey medical market.
Finally, whenever you consider California’s hashish 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 not too long ago wrote about all of the dangerous habits that also happens in California (even with licensing in play) and in addition concerning the prime 5 most harmful hashish contracts on this state, however this submit is devoted to these contractual and company relationships and constructions I’ve seen most not too long ago within the Golden State that maintain developing many times. These preparations both skirt the hashish guidelines fully, 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 underneath one other firm’s license.
The variety of occasions I’ve seen a licensee enable an unlicensed enterprise to function inside its premises is rising quickly in California. In most different states, the laws make abundantly clear that any firm engaged in business hashish exercise, it doesn’t matter what, would require a hashish license and that you simply can’t function an unlicensed hashish enterprise inside 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 business hashish 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/underneath/by means of a licensed firm, conducting business hashish exercise as if the unlicensed firm owns the license. (And issues develop into very complicated from a efficiency obligation perspective when one in every of these unlicensed firms is an fairness proprietor within the licensed enterprise, however can be performing as, let’s say, a administration firm of that licensed enterprise on the similar time).
These preparations, in fact, 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 need to or can’t safe their very own licenses, regardless of conducting all of the regulated business hashish exercise. I’ve little doubt that when the BCC lastly flips into enforcement mode that it’s going to begin actually analyzing these relationships to find out who is definitely conducting business hashish exercise in violation of the principles (in all probability numerous of us).
2. Licensee contracts with unlicensed events that function at a licensed facility.
These sorts of contracts develop into more and more difficult due to no 1 above. If you happen to’re a licensee and also you’re being introduced with a contract from an unlicensed social gathering that’s working inside one other firm’s licensed premises, it’s good to proceed with excessive warning. Even when an unlicensed firm is disclosed underneath one other licensee as an “proprietor” or a “monetary curiosity holder,” that doesn’t imply that that firm can begin enterprise its personal business hashish exercise carte blanche.
Recall, business hashish exercise can solely be performed between licensees. That’s to not say that an unlicensed firm can’t help a licensee with its business hashish exercise, but when that unlicensed firm is inking its personal contracts with none point out of the particular licensee underneath which it operates, you’re going to have important 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 immediately 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 can be co-branded with the unlicensed firm’s info and mental property). With out extra steering from the BCC, it’s not troublesome to find out that such a contract violates Rule 5032.
three. IP licensing and white labeling.
Thanks once more to the BCC, IP licensing with hashish licensees in California is under no circumstances simple. Whereas unlicensed firms can license their IP to hashish 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-about an “proprietor” underneath BCC laws; and which means disclosure of the unlicensed social gathering 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 the usage of 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” could make the licensor an “proprietor” of the hashish licensee. The identical situation could happen with white labeling, the place an excessive amount of management over formulations and product compilation may quantity to illegal “possession” over the hashish licensee.
I’m optimistic that there are IP licensing and white label and provide agreements in California which have created secret house owners far and wide due to the extent of management in these agreements given to unlicensed events. The BCC has little or no steering out about these relationships, so its scrutiny of those agreements will in all probability be on a case-by-case foundation if and when such relationships are found.
four. Disclosure points.
Close to as I can inform when speaking to of us, 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 need to keep away from these points altogether in the event that they may also help it (which is simpler mentioned than finished). Particularly with the BCC, in case you’re an proprietor that’s an entity, you’re disclosing each single proprietor in that entity, even when they personal underneath 20% of the entity. This implies you’ll disclose not solely your fairness house owners at 20% or extra AND all people in a management, route, or administration positions, however you’ll additionally disclose your entire monetary curiosity holders (with only a few exceptions) which are at 19% or much less in fairness. (And, sure, this consists of 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 understand that they’ll violate the principles in the event that they fail to well timed make these disclosures. Regardless of that truth, I see numerous transactions and cap tables from licensees the place they understand 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 form of default or obligation round these disclosures — which is an enormous drafting mistake.
5. Working and not using a provisional license.
For some cause, some stakeholders are underneath the impression that they will proceed to function if they’ve native authorization however no state license. That is simply useless flawed. And even in case you have native authorization and have utilized for an annual license in an effort 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 important 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 hashish firms in California, be sure that your goal has each native authorization and a state license earlier than pulling the set off.
California hashish has sure pitfalls which are not like every other state as a result of nascent nature of the licensed trade and ambiguities created by the regulators. Sadly, these pitfalls and ambiguities aren’t being addressed with extra steering and even constant BCC enforcement. In any occasion, proceed with warning on the market and make sure you learn the wonderful print in your proposed agreements and within the guidelines.