Cozen O’Connor: Recent Decisions Impacting Cannabis Contracting and How to Protect Your Business

Recent Decisions Impacting Cannabis Contracting and How to Protect Your Business

November 26, 2019

For the second time this year, a federal court in the Western District of Washington revealed its inclination to dismiss claims seeking equity in cannabis businesses. The espoused concern is not simply illegality of cannabis federally, but more specifically over the request for an interest in profits derived from a federally illegal business, which if granted, would require the court to “mandate illegal conduct” due to the federal prohibition of cannabis under the Controlled Substances Act (CSA).

The most recent decision issued last month was an order to show cause why the complaint in Left Coast Ventures, Inc. v. Bill’s Nursery, Inc., should not be dismissed. In this case, Bill’s Nursery lacked the independent cultivation experience necessary to qualify for a cultivation license under Florida law — so it formed a partnership with experienced cultivator, Left Coast Ventures. Pursuant to the parties’ agreement, in exchange for paying, applying for, and successfully receiving the license, Left Coast would receive an option to purchase shares in Bill’s Nursery. Left Coast did the work but the license application was denied by the Florida Department of Health in 2015.

Thereafter, Florida changed its law and expanded its medical cannabis program. Bill’s Nursery was then able to obtain a license through an administrative procedure without reapplication and based on the original application facilitated by Left Coast. After discovering this, and after Bill’s Nursery refused Left Coast’s attempt to exercise its option, Left Coast sued Bill’s Nursery in Washington state court, claiming that Bill’s Nursery reneged on the agreement. Bill’s Nursery argued that the license, ultimately received four years after the termination of the contract with Left Coast, was of a different nature than the one originally applied for and that the original contract with the option had terminated. The suit was removed to federal court based on diversity jurisdiction.

In addition to arguing that Left Coast’s contractual option right terminated following denial of the original application in 2015, Bill’s Nursery raised a “federal illegality defense” based on a decision issued out of the same court on August 28, 2019 in Polk v. Gontmakher, No. 2:18-cv-01434-RAJ, 2019 WL 4058970 (W.D. Wash. Aug 28, 2019). In that case, the court concluded that federal law prohibited the enforcement of an agreement between partners in a cannabis growing operation. Citing the CSA, the Polk court found that “awarding [the plaintiff] an ownership interest in, or profits from, [the cannabis-related business] contravenes federal law.” 

Bill’s Nursery went so far in its brief to argue that the CSA and federal case law required the court to dismiss any claim alleging ownership in a marijuana grow operation, stating: “The court lacks the power to order the transfer of a business that is illegal under federal law … As a medical marijuana dispensary licensed under Florida law, Bill’s Nursery necessarily operates in violation of the CSA’s prohibition of the cultivation and sale of marijuana.” Left Coast maintains it is the current holder of a valid option to buy Bill’s Nursery. The court’s decision on the motion to dismiss in Left Coast remains pending. Given the order to show cause and the Polk decision out of the same court just a few months prior, odds weigh in favor of dismissal.

So what does this jurisprudence mean for cannabis industry participants? A few things:

First, don’t panic. These two decisions are outliers from an otherwise steady trend of federal courts willing to enforce contractual agreements entered into by sophisticated businesses — cannabis or not.

For example, in The Green Earth Wellness Center, LLC v. Atain Specialty Insurance Company, 163 F. Supp.3d 821 (D. Colo. 2016), the U.S. District Court for the District of Colorado found that an insurance policy insuring a cannabis business was enforceable. Citing “a continued erosion of any clear and consistent federal public policy in th[e cannabis] area,” that court “decline[d the insurer’s] indirect invitation to declare the [insurance p]olicy void on public policy grounds.” It concluded that the insurer, “having entered into the [p]olicy of its own will, knowingly and intentionally, is obligated to comply with its terms or pay damages for having breached it.”

More recently, another federal court in Oregon permitted a plaintiff to try to recoup the benefit of its cannabis-related bargain. In Value Linx Services, LLC v. Linx Card, Inc., No. 3:18-cv-02126-HZ, 2019 WL 3502895 (D. Or. Aug. 1, 2019), the parties disputed a business arrangement involving the sale of “gift cards bought at kiosks within cannabis dispensaries to allow consumers to purchase cannabis products without cash.” The U.S. District Court for the District of Oregon refused to dismiss the plaintiff’s sufficiently pled breach-of-contract, promissory estoppel, and quantum meruit claims. It did not conclude that such claims must fail because the business arrangement was in any way against the CSA or any other federal law.

Second, consider ways to insulate your business from judicial anomalies like this. For instance, parties could include mandatory binding arbitration clauses in agreements that pledge, transfer, or otherwise grant options to transfer interest in cannabis businesses. Arbitration is a growing trend in the cannabis industry and one that is likely to continue, particularly given its ability to avoid the creation of bad law for business.

Third, if your business finds itself in this type of dispute, the relief requested may drive the result. If, as in Polk and Left Coast, the plaintiff seeks specific performance and asks the court to award an interest in a cannabis business, the federal illegality defense under the CSA may come into play to invalidate that kind of claim. Conversely, a federal court may be more inclined to award money damages to put a party back in the financial place occupied prior to execution. Indeed, the Polk court insinuated as much in its decision dismissing that case. These are points to keep in mind depending which side of the bench you’re on in such a matter.

Federal and state policy and law in this area, and in all areas involving cannabis, are constantly evolving. As such, it is important to consult with counsel prior to taking any cannabis-related action.

DISCLAIMER: Cannabis is still classified as a Schedule I controlled substance by the U.S. Drug Enforcement Agency, and as such it remains a federal crime to grow, sell and/or use cannabis. Any content contained herein is not intended to provide legal advice to assist with violation of any state or federal law.

 


Authors

Abby L. Sacunas

Member

asacunas@cozen.com

(215) 665-4785

Related Industries