Historic Recommendation by HHS to Reschedule Marijuana to Schedule III

In a momentous announcement, the U.S. Department of Health and Human Services (“HHS”) has recommended that marijuana be rescheduled from Schedule I to Schedule III under the Controlled Substances Act (the “CSA”).

Schedule I is the most restricted tier under the CSA and includes heroin and, for now, marijuana. Substances on Schedule I are those found to have no currently accepted medical value and a high potential for abuse. Schedule III substances, on the other hand, are those found to have a potential for abuse less than Schedule I or II substances and can be obtained with a prescription. Examples include ketamine and anabolic steroids. HHS says it’s time for marijuana to be moved to Schedule III.

HHS shared its conclusions and recommendation with the Drug Enforcement Administration (“DEA”), which has the ultimate authority to schedule, reschedule, or de-schedule substances under the CSA absent an act of Congress. The DEA confirmed receipt of the HHS recommendation and indicated it would now initiate its own review. President Biden directed federal agencies to review the current scheduling of marijuana under the CSA in October 2022, noting that marijuana is currently scheduled alongside heroin and LSD and on a more restrictive tier than fentanyl and methamphetamine. HHS Director Xavier Becerra had publicly stated that his department would conclude its review before the end of 2023.

This is a historic moment for advocates of marijuana reform and for those seeking an end to marijuana prohibition.

For now, however, uncertainty continues for marijuana businesses in state-legal markets. There is no timetable for the DEA to complete its review. The last time the DEA reviewed marijuana’s scheduling under the CSA, it took over two years, required input from the Food and Drug Administration, and ultimately resulted in marijuana remaining on Schedule I.

Even if the DEA reaches the same conclusion as HHS and marijuana is ultimately rescheduled as a Schedule III substance, marijuana regulated by the states will remain federally illegal. Twenty-three states have legalized adult-use marijuana. Fifteen more have legalized marijuana use only for medical purposes. Marijuana businesses in one of those states would continue to exist in limbo; they are legal and regulated by state law but federally illegal. Rescheduling may be a step toward federal decriminalization, but it is not the last stop.

Despite rescheduling marijuana to Schedule III does not amount to decriminalization, it may have tax benefits for marijuana businesses. Section 280E of the U.S. tax code prohibits deductions and credits for businesses trafficking in controlled substances, but this prohibition applies only to Schedule I and II drugs. Additionally, a change to Schedule III could result in greater access to financial services for state-legal operators, including access to more advantageous stock exchanges for publicly-traded companies.

If you have questions about how HHS’s recommendation to change marijuana to Schedule III under the CSA affects your marijuana business, please don’t hesitate to contact Keenan Jones, Tom Haren, or any other member of the Frantz Ward Cannabis Law and Policy team.

North Carolina Medical Marijuana Bill Advances Through State Senate, Moves to the House of Representatives for Consideration

The cannabis industry shows no sign of slowing down as state lawmakers continue the push to legalize medical marijuana across the country. As February draws to a close, eight states are grappling with bills to create medical cannabis programs. Among those eight is North Carolina, where the proposed Senate Bill 3, titled the Compassionate Care Act (“CCA”), passed the full North Carolina Senate on March 1.

The bill, sponsored by Republican Sens. Bill Rabon and Michael Lee and Democrat Sen. Paul Lowe, proposes the legalization of medical cannabis use for patients diagnosed with one or more enumerated conditions. It would also authorize the Department of Health and Human Services and a Medical Cannabis Production Commission to evaluate applications and issue up to ten licenses.

Notably, the CCA does not differentiate between cultivators, processors, and dispensaries. Each licensee would be deemed a “supplier” and may operate both “production facilities” for the cultivation and processing of marijuana and up to eight dispensaries, or “medical cannabis centers.”

Compared to the “comprehensive” medical use programs adopted in other states, the CCA’s current text is limited. According to Senator Rabon, the legislative intent “is to only make changes to existing state law that are necessary to protect patients and their doctors from criminal and civil penalties.” The list of qualifying conditions is also limited; unlike Ohio, North Carolina would not permit patients suffering from chronic pain to obtain a marijuana certification. In fact, this version of the CCA only recognizes eleven qualified diagnoses that are not related to hospice or end-of-life care. However, unlike some states, the bill would permit smoking of medical marijuana by registered patients, with some restrictions.

While passage of the bill would be a well-earned win for medical marijuana advocates in North Carolina, cannabis business owners looking to develop a presence into the state should take care to familiarize themselves with the proposed bill. Seasoned owners and operators will recognize certain aspects, such as the creation of a seed-to-sale tracking system and a state registry of all qualified patients and caregivers. Other familiar provisions include an annual license renewal requirement, license caps, and the disqualification from licensure of individuals convicted of certain crimes.

However, license-seekers will want to pay close attention to the proposed bill’s license application requirements, which include:

  • Proof the applicant has been a state resident for at least 2 years and will be the majority owner of each dispensary and production facility proposed. (Note that in Ne. Patients Grp. V. United Cannabis Patients & Caregivers of Me., 45 F.4th 542 (2022), the First Circuit struck down a similar residency requirement in Maine on the grounds that such requirements violate the “dormant Commerce Clause,” which prohibits states from discriminating against interstate commerce)
  • Documentation of the applicant’s expertise in controlled environment agriculture and the ability to engage in growing or processing of cannabis, as well as product development, quality control, and inventory management of cannabis.
  • Proof that the applicant has sufficient liquid and non-liquid assets to operate for two years.
  • Disclosure of the names, addresses, and dates of birth of any individual owning more than 5% of a dispensary or production facility to be operated under the license.

Under the proposed text, suppliers would be required to begin cultivation within 120 days of licensure and begin the sale of cannabis and cannabis-infused products within 270 days of initiating cultivation. Suppliers would also pay a monthly fee to the Department in an amount equal to 10% of gross revenue. This 10% fee would likely represent the largest fee imposed on medical marijuana operators in any state market, and it remains to be seen if operators could be profitable with a fee of this size while still being prohibited from taking standard business deductions due to IRC 280E.

The Compassionate Care Act now moves to the North Carolina House of Representatives. While last year’s proposed medical use legislation died in the House, Republican House Speaker Tim Moore stated that he “would not be surprised at all” if the House votes in favor of passage this time around.

This article provides a brief overview of North Carolina’s Compassionate Care Act in its current state. The bill was amended several times during the Senate committee process, including amendments designed to ensure equitable distribution and access to medical cannabis centers in underserved counties. As is often the case with legislation, the House is likely to make additional changes to the proposed bill before it heads to the Governor’s desk.

If you are interested in pursuing a North Carolina medical marijuana license, or if you have questions about North Carolina’s Compassionate Care Act, please don’t hesitate to contact a Frantz Ward cannabis attorney.

What Does A Change in Senate Control Mean for Ohio’s Marijuana Laws?

With 2020 in the rearview mirror and much of the country suffering from election season fatigue, many people were not following yesterday’s special election in Georgia. However, with control of the United States Senate hanging in the balance, the results of the election have far reaching implications for a number of policy matters, including marijuana reform. Those implications are not limited to federal law – Ohio’s own marijuana laws are likely on the table.

On December 4, 2020, the House of Representatives passed the MORE Act, which would deschedule marijuana under federal law and implement other progressive marijuana reforms. That bill did not receive a vote in the Republican-controlled Senate. However, then-Minority Leader Chuck Schumer promised that, if the Democrats were to retain the majority, he would do “everything” he could to end federal marijuana prohibition.

Yesterday, two Republican Senators faced off against two Democratic challengers in the state of Georgia’s special election. Multiple news outlets have already called one of the races for the Democratic challenger, Raphael Warnock. As of writing this post, challenger Jon Ossoff is leading incumbent senator David Perdue. If John Ossoff wins the race – which seems likely – then the United States Senate will be evenly between Republicans and Democrats, positioning Vice President-elect Kamala Harris to cast any required tiebreaking votes. Remember, she had previously committed in this past fall’s Vice Presidential Debate to decriminalize marijuana if elected.  

If Democratic leaders follow through on their prior commitments to reform federal marijuana laws by descheduling marijuana, that could have an immediate impact here in Ohio. Pursuant to Revised Code section 3719.43, when a drug is removed from the federal list of controlled substances, such removal is “automatically effected” under Ohio law. In other words, the possession and sale of marijuana in Ohio would “automatically” be legal (and basically unregulated) outside of the medical marijuana control program.

This would put Ohio lawmakers in a precarious position. They would be faced with a choice to either adopt a legal framework for a new adult use marijuana program, or to pass a new law effectively re-prohibiting marijuana outside of the MMCP at a time when public support for adult use marijuana programs in Ohio is only growing.

And Ohio is not alone in facing this new reality. Numerous states are considering adopting adult use programs this year, including New York, Connecticut, New Jersey, and Virginia. Even Republican-leaning states like South Dakota and Montana are reckoning with ballot initiative results that legalized adult use marijuana in their own states.

If one thing is clear following these past elections, it is that 2021 seems could be the year that marijuana reform advocates have been waiting for.

If you have questions about what these new developments mean for you and your cannabis business, please do not hesitate to call Tom Haren or one of the other Frantz Ward Cannabis Law Attorneys.

COVID-19 Prompts Changes to Ohio’s Medical Marijuana Rules

Due to the unprecedented issues created by the COVID-19 pandemic, many different industries have had to change how they operate to comply with restrictive orders to help stop the spread of the virus. One of the industries that has been most affected by this virus is the Ohio medical marijuana industry. Thankfully, the Ohio Board of Pharmacy (“Board”) has issued guidance and temporary relief from some regulations to help the medical marijuana industry safely operate during this pandemic.

Orders Over the Telephone
On March 20, 2020, the Board issued guidance permitting patients and caregivers to place an order for the sale of marijuana through the telephone. The patient/caregiver must contact the dispensary and orders must be taken on the telephone system on the dispensary’s premises. When the patient/caregiver arrives, his/her photo identification and registry identification card must be verified when he/she arrives and at the point of sale terminal. Payments may not be accepted over the phone. Product not picked up by the close of business must be returned to the vault or safe. 

Interestingly, some states, such as Michigan and Illinois, have begun allowing online ordering – though online orders are not yet permitted in Ohio. A copy of the Board’s telephone ordering guidance can be accessed here.

Caregiver Registration
On March 23, 2020, the Board issued guidance permitting a patient to have up to three caregivers, and a caregiver to have up to three patients. Also, caregivers can now be linked to patients through either the patient’s physician, or by applying directly to the Board for patients who are already in the registry. Hopefully, this will grant patients greater access to caregivers when some caregivers may be quarantined or reluctant to leave their homes. A copy of this guidance and instructions for submitting the application directly to the Board can be accessed here.

Curb-side Pickup
On April 3, 2020, Ohio joined a growing list of states to temporarily permit sales to patients and caregivers outside the dispensary department. Transactions must occur on dispensary property, security personnel must be present, and transactions must occur within the coverage of one of the security cameras. The guidance specifically prohibits home or off-site delivery. If curb-side pickup works well and is safe, the Board may make this rule change permanent. 

Interestingly, some states, such as Michigan and Maryland, are allowing delivery during the pandemic. Also, California permitted deliveries prior to the pandemic. Home delivery is a popular option in other states, especially during “Stay at Home” or other “Shelter in Place” orders. It is possible that the Board will re-evaluate its position relative to home delivery in future rule changes. The Board may review how home-delivery is working in other states and may being to permit it during the pandemic, which could lead to it becoming permanent. A copy of the curb-side pickup guidance can be accessed here.

Photo ID Requirements
On April 14, 2020, due to closures of BMVs throughout Ohio, the Board issued guidance permitting renewal of registrations and recommendations for patients and caregivers with identification that expired on or after February 1, 2020, so long as the document is legible and it is one of the forms of identifications permitted under Ohio Administrative Code § 3796:7-2-01. If the identification expired before February 1, 2020, patients can register with a birth certificate and one of the identifications permitted under Ohio Administrative Code § 3796:7-2-01. Dispensaries will be required to honor this form of identification. Patients will have 60 days after the rescission of this guidance to obtain valid photo identification.

Moreover, the guidance permits birth certificates as acceptable identification for minors or adults with legal guardians, and dispensaries will be required to accept this form of identification for these patients. Patients registering with birth certificates shall have 60 days after the rescission of this guidance to obtain valid photo identification.

Lastly, the guidance provides for alternative forms of identification for currently registered patients or caregivers who have lost their identification. One option is to present a birth certificate and a social security card. Another option is to provide a birth certificate or social security card, and either a current utility bill, bank statement, government check, paycheck, or other government document that shows the patient/caregiver’s name and address. This guidance can be accessed here.

90-Day Supply Resolution and Guidance
On April 17, 2020, the Board is establishing a new process to calculate a patient’s 90-day supply. Under the prior process, a patient could only purchase medical marijuana for the remaining days from the 90-day recommendation supply period. For example, if a patient had not purchased medical marijuana until day 40 of his/her 90-day supply period, the patient could only purchase up to 50-days-worth of supply.

Under the new process, the 90-day recommendation will now be divided into two 45-day fill periods. The first fill period begins when the patient receives the recommendation. Importantly, a patient may now purchase the entire 45-day supply of medical marijuana, regardless of when the purchase is made during the period. If the patient does not purchase the entire 45-day supply in the first period, the patient may not purchase more than a 45-day supply in the second fill period. A copy of this guidance can be accessed here.

Some of these changes will likely remain temporarily in place only during the pandemic, such as the relaxed photo identification requirements and caregiver registration requirements. However, for the other changes, the Board may review the efficacy of these new rules and make some permanent.

If you have questions about how the coronavirus is impacting the medical marijuana industry, please contact a member of Frantz Ward’s Cannabis Law and Policy team.

Transfer, Administration, and Taxation Issues For Marijuana-Related Assets in Estate Planning

Legal cannabis is one of the fastest-growing markets in the United States. With eleven states permitting recreational use as of March 2020 and forty-seven states allowing some form of medicinal use, estimates project more than $23 billion in consumer spending on legal cannabis in the United States by 2022. Despite rapid state-level changes, marijuana remains classified as a Schedule I controlled substance under federal law. The difficulties in navigating this legal landscape are especially prevalent in estate planning, and the presence of marijuana-based assets in an estate plan may have broad impacts on transfers, administration, and taxation.

These issues arise for clients, potential fiduciaries, and potential beneficiaries when an asset to be transferred or otherwise disposed of upon the death of an individual is related either directly or indirectly to marijuana.  There are two general categories of assets at issue: assets owned by an individual or business that have direct contact with marijuana, such as cultivation manufacture/processing, or sale of marijuana, and assets owned by an individual or business that are related to marijuana such as manufacture or sale of products utilized in the production or consumption of marijuana, real estate upon which production is conducted, or a provider of ancillary services such as accounting, banking, or inventory management. The former requires a greater level of attention in structuring an estate plan.

Transferring Marijuana-based Assets

A preliminary consideration for marijuana-based assets is whether a testamentary instrument may legally transfer ownership. Owners of marijuana businesses should invest in establishing a clear business succession plan at the outset and should investigate buy-sell agreements, cross-purchase plans, or entity purchase plans. Careful planning on the front end may avoid some of the more difficult issues discussed below.

The next step is to determine if a beneficiary may take ownership of the asset. State laws vary on the restrictions preventing minors from possessing or owning such assets, either outright or in trust, and it is important to consider how a minor beneficiary may benefit from inherited assets without contravening those restrictions.  Similarly, a beneficiary who has reached the age of majority may nonetheless be restricted in their ability to take ownership by virtue of a prior conviction for a disqualifying offense. As an added complication, each state has differing prerequisites and procedures for transferring ownership of a state-issued marijuana license. Ownership as well as control of marijuana businesses are both heavily scrutinized by state regulators, and many states place limitations on the timeframe in which ownership or control may be changed. The qualifications and application process to transfer an existing license or issue a new license may cause significant delays in the ability to transfer or may prevent transfer altogether. Again, a clear business succession plan can serve to avoid these pitfalls.

It is important to note that the laws of the decedent’s domicile prior to death will govern the transfer of assets by a decedent, but the laws of the beneficiary’s domicile will be applicable in determining whether or not they may take possession of the asset.

Administering Marijuana-based Assets

Another potential issue is whether a named fiduciary, such as the executor or administrator of an estate, property management agent, or trustee, is able and willing to serve. Given the uncertainty surrounding marijuana-based assets on the federal level, a fiduciary may be concerned about exposure to civil and criminal liability. While individuals may rely on the enforcement priorities outline in the Cole II memorandum issued August 2013 by the Department of Justice, a corporate fiduciary may decline its appointment. A fiduciary may also face challenges in working with financial institutions in light of the comprehensive requirements imposed by FinCEN in its 2014 guidance, including filing Suspicious Activity Reports and other onerous paperwork under its anti-money-laundering regulations. Because states closely regulate the control and operation of marijuana businesses, a fiduciary may face the same issues as a beneficiary in undergoing the application and approval process by the state’s regulatory authority. 

From the fiduciary’s perspective, marijuana assets present other unique administration considerations.  A fiduciary who is bound to invest in the same manner as a prudent investor under the Uniform Prudent Investor Act in over 40 states may find it challenging to assess marijuana investments given the uncertain degree of risk. Further, administering marijuana businesses presents unique income tax considerations. Under Section 280E of the Internal Revenue Code, tax deductions and credits are not available to companies whose business consists of “trafficking in controlled substances.” 26 U.S.C. §280E. As a result, marijuana businesses are not allowed to take tax deductions on normal business expenses like employee salaries, rent, and utility bills, increasing their effective federal tax rate significantly.

Business and Estate Taxation of Marijuana-based Assets

Even though marijuana-based assets are illegal federally, the IRS can still demand payment of estate tax on any transferrable business assets connected with an illegal enterprise. The IRS has held that although an item may be illegal to own, an illicit market may nevertheless exist to measure the value of the property for estate tax purposes. Although the federal estate tax exemption remains high, marijuana-based assets have the potential for tremendous value due to the rapid growth of the industry in the United States.

Clients with assets that relate directly or indirectly to marijuana should give careful attention to the unique considerations for estate planning. Contact Frantz Ward’s Cannabis Law and Policy group to plan ahead for the transfer, administration, and taxation of marijuana-based assets.

Cannabis Partner Tom Haren Quoted in Marijuana Business Daily Article


Excerpt from article:

Tom Haren, partner at Ohio law firm Frantz Ward, sees the current regulatory trend a bit differently.

More permitting issues popping up

“I don’t know if they (regulators) are necessarily getting more assertive as much as the life cycle of the industry is now when these (licensing) issues are starting to crop up,” Haren said.

For example, he said, Ohio developed its medical marijuana regulations in 2016 and 2017, at a time when there were few publicly traded companies and little merger and acquisition activity.

“It was a different world,” Haren said.

Like many states, Ohio drafted strict ownership and license-transfer requirements, regulations that haven’t necessarily kept pace with industry realities.

Some states, for example, require clean criminal records for all owners of a business. That’s a requirement impossible to meet by publicly held companies with thousands of stockholders.

The reality is that the cannabis industry has evolved into one that reflects almost every industry, with fluid ownership, Haren noted.

“Some states don’t want licenses to be sold, but that’s not how business works, that’s not how markets work,” Haren said. “I think we really need to reevaluate how we treat the industry.”

“In my experience, companies are making every effort to comply with the rules,” Haren added. “No company wants to have to surrender licenses or get in trouble with the regulators.”

Ohio’s Hemp Industry: Five Things to Know

Despite the Buckeye State’s late start in the hemp industry, Ohio has quickly turned into a national trendsetter, becoming one of the first states to obtain USDA approval of its hemp program. With the Ohio Department of Agriculture expected to finalize its administrative rules in a matter of days, Ohioans could find themselves with the ability to be among the first to be licensed to produce hemp and hemp-derived products in 2020.

So, with that in mind, here’s what you need to know:

  1. License applications should arrive soon. One of the final steps in approving Ohio’s hemp rules occurs on Thursday, January 16 when the hemp rules are before the Joint Committee on Agency Rule Review (JCARR). Assuming there are no snags, Ohio regulators anticipate that license applications for Ohio hemp cultivators and processors will be live at the end of January or early February. Regulators are moving quickly to ensure that licenses are issued in advance of the 2020 growing season.
  2. Ohio tests for Total THC Content. Similar to the USDA’s Interim Final Rule, Ohio will be utilizing a “Total THC” testing requirement to determine compliance with SB 57. That means that the sum of delta-9 THC and 87.7% of THCA must be below 0.3%. (Delta-9 THC + 87.7% THCA = Total THC). Farmers in many states that have been cultivating hemp under the 2014 Farm Bill have run into problems when attempting to meet this threshold.
  3. Hemp crops must be tested within 15 days prior to harvest. Again, following the USDA’s lead, Ohio will require hemp cultivators to have their crops tested within 15 days of harvest. Under the Ohio Department of Agriculture’s proposed rules, hemp plant material testing can be done only by the Department, unless it contracts with third parties to provide those services.
  4. Hemp processor applications are a bit more robust for companies extracting cannabinoids in Ohio. Hemp processor license applications will be designed to be simpler than Ohio’s medical marijuana applications. But applicants seeking to extract CBD and other cannabinoids from hemp in Ohio will have to meet requirements that some do not. For example, those companies will have to provide an additional operational plan at the time of application and will also need to post a surety bond of either $10,000 or $20,000, depending on the prior year’s revenue.
  5. There are restrictions on where you can locate your hemp business. R.C. 928.03(T) requires the Department to establish a setback distance from pre-existing medical marijuana cultivators. In its proposed rules, the Department established a setback of one-half mile between medical marijuana and hemp cultivators. In addition, hemp cultivators and processors cannot be located within five hundred feet of a school or public park, unless prior approval of the Department is obtained.

There are many more regulatory and practical issues to consider when operating a hemp business. If you have questions or would like to learn more about Ohio’s hemp industry, please do not hesitate to contact Tom Haren and the other Frantz Ward cannabis attorneys.

The “Illegality Defense” in Cannabis Contracts

 In recent years, courts across the country are sending mixed signals as to whether the “illegal contract” or “illegality” defense prevents the enforcement of cannabis contracts. The inconsistencies among courts present significant hurdles for investors and distributors who cannot be certain any contract will be enforced by a federal court. After what appears to be a pattern of enforcing such contracts, two recent cases may indicate a slowing of the momentum, or may be outliers from one federal court.

Specifically, for the second time in two months, a federal court in Seattle indicated it may be prohibited from enforcing a contract between cannabis companies based upon the illegality doctrine and the fact that marijuana remains a controlled substance under federal law. In Left Coast Ventures v. Bill’s Nursery, No. 2:19-CV-1297-MJP, (W.D. Wash. October 31, 2019), the plaintiff asked the court to enforce a contract requiring Florida grower Bill’s Nursery to sell its marijuana distribution business to Left Coast Ventures. Bill’s Nursery moved to dismiss, claiming the contract terminated several years before Left Coast purported to exercise its option. After the parties completed briefing on the motion to dismiss, the court sua sponte issued an order to show cause, finding “the contract at issue may be unenforceable” under the Federal Controlled Substances Act (“CSA”). According to the court, it is precluded from awarding an ownership interest in a business that is illegal under federal law.

In response, Bill’s Nursery argued the court may not order an illegal act. Because the sale, distribution and cultivation of marijuana remains illegal under federal law, Left Coast’s claim for specific performance – which would effectively award an ownership interest in an illegal business – failed as a matter of law. Unsurprisingly, Left Coast disagreed, arguing (1) the majority of federal courts to consider the illegality defense under similar circumstances refused to dismiss on that ground, and (2) enforcing the contract does not mandate illegal conduct. According to Left Coast, it seeks both monetary damages and specific performance of an option agreement to purchase shares in Bill’s Nursery. The court has yet to render a decision.

The Left Coast case follows on the heels of a similar decision by the Western District of Washington in Polk v. Gontmakher, No. 2:18-CV-01434-RAJ, 2019 U.S. Dist. LEXIS 146724, at *2 (W.D. Wash. Aug. 28, 2019). In that case, the plaintiff sued his former partner in a marijuana growing business, arguing he was entitled to an ownership interest as well as past and future profits. Treading lightly, the court held that federal law precluded enforcement of the agreement, because under the CSA, the production, distribution and sale of marijuana remains illegal. The court noted the “nuanced approach” in applying the illegality defense, acknowledging that it may have been permissible to award the plaintiff damages. However, because the complaint sought an ownership interest in the business, such a result would contravene federal law.

These recent decisions are squarely at odds with the general trend. In reality, federal courts are increasingly more willing to recognize cannabis related businesses – which are legal under the laws of several states – and enforce both the private and public obligations surrounding them. For example, in Street v. ACC Enters., Ltd. Liab. Co., No. 2:17-cv-00083-GMN-VCF, 2018 U.S. Dist. LEXIS 167299, at *13-14 (D. Nev. Sep. 27, 2018), a case involving the breach of a multi-million dollar loan agreement to fund a cannabis cultivation facility, the court was able to “provide a remedy for Plaintiff that both complies with Nevada substantive law and does not conflict with federal law. This finding comes from the fact that several requirements of the First and Second Promissory Notes command the Defendants to use the loaned funds for solely legal acts.” Because the potential remedy did not mandate illegal activity, the court denied plaintiff’s motion to dismiss.

In Mann v. Gullickson, 2016 WL 6473215, at *9 (N.D. Cal. Nov. 2, 2016), the Northern District of California rejected an illegality defense on summary judgment in a breach of contract action involving medical cannabis-related businesses, holding that mandating payment for the business did not require the defendant to “possess, cultivate, or distribute marijuana, or to in any other way require her to violate the CSA.” Similarly, in Ginsburg v. ICC Holdings, LLC, 2017 WL 5467688, at *9 (N.D. Tex. Nov. 13, 2017), the Northern District of Texas rejected the illegality defense to a breach of contract action regarding loans for a medical cannabis business, explaining “federal courts do not take such a ‘black-and-white’ approach to enforceability.” Rather, courts must balance “the pros and cons of enforcement, taking into account the benefits of enforcement that lie in creating stability in contract relations and preserving reasonable expectations and the costs in forgoing the additional deterrence of behavior forbidden by the statute.”

Likewise, in Kenney v. Helix TCS, Inc., 939 F.3d 1106 (10th Cir. 2019), the Tenth Circuit Court of Appeals held that a defendant could not escape its obligations under the Fair Labor Standards Act by relying on the illegality defense. In that case, Helix, a company that provides security to cannabis businesses, failed to pay its employee overtime as required by the FLSA. Helix moved to dismiss the claim, arguing that Kennedy was not entitled to protection under the FLSA because cannabis is illegal under the CSA. According to Helix, its employees assume the risk that they will be criminally sanctioned for their work and thus are denied the benefits of federal law. A three-judge panel disagreed, holding the FLSA indeed applies to cannabis businesses. The court stated that “employers are not excused from complying with federal laws just because their business practices are federally prohibited.”  The court further noted that its holding was consistent with that of Greenwood v. Green Leaf Lab LLC, No. 3:17-cv-00415-PK, 2017 U.S. Dist. LEXIS 125143, at *10 (D. Or. July 13, 2017), where the U.S. District Court for the District of Oregon addressed precisely the same issue.

In sum, the differing approaches are largely based on the remedy requested by a cannabis plaintiff. While courts have been willing to enforce contracts seeking monetary damages, they are generally unwilling to grant specific performance if it would require the court to order that a plaintiff be permitted to engage in activity illegal under federal law. This distinction highlights the need for careful evaluation when drafting agreements, and thoughtful consideration from counsel when seeking to enforce them through litigation.

If you have questions about remedies when a cannabis contract is breached, please do not hesitate to contact a member of Frantz Ward’s Cannabis Law & Policy team.

Frantz Ward Client Obtains Favorable Ruling in Dispensary License Litigation

An Ohio judge ordered the Board of Pharmacy to reconsider its denial of a provisional dispensary license to Frantz Ward’s client, Pure Ohio Wellness, LLC.

Pure Ohio was the highest-scoring dispensary applicant in the state’s Southwest-7 District, which includes Fayette, Madison, and Greene counties. However, the Board denied Pure Ohio a license and instead awarded a license to a lower-scoring applicant as a result of an Ohio statute that required the Board of Pharmacy Board to issue not less than fifteen percent of dispensary licenses to entities owned and controlled by members of economically disadvantaged groups.

The Court found this statute to be unconstitutional on its face and remanded the matter back to the Board. This ruling follows a decision by the Franklin County Court of Common Pleas to strike down a similar provision governing the award of Ohio medical marijuana cultivator and processor licenses.

After receiving a copy of the decision, Pure Ohio’s President, Larry Pegram, provided this statement:

“We were very happy to receive the Judge’s ruling today. As a currently vertically-integrated Ohio medical marijuana company we are focused on providing the best and safest cannabis available on the market. We look forward to ultimately receiving our third dispensary license so that we can provide much needed relief to more of Ohio’s patients.”

To view a copy of the ruling, please click here.

Cannabis Industry Faces Another Obstacle as Tax Court Upholds Section 280E

In a blow to the American cannabis industry, the United States Tax Court found that Section 280E of the Internal Revenue Code (“IRC”) did not violate the Eight Amendment to the United States Constitution. Northern California Small Business Assistance Inc. v. Commissioner, 153 T.C. 4 (2019). The Petitioner in Northern California was a legal medical marijuana dispensary in California, which challenged the application of Section 280E. Section 280E states:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consist of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

Despite legalization of marijuana use in several states, under federal law marijuana remains a Schedule I controlled substance within the meaning of the Controlled Substances Act.[1] The Petitioner’s challenge to Section 280E was based on three arguments: (1) that Section 280E is a penalty and an unconstitutional violation of the Eighth Amendment; (2) that Section 280E only limits the business deductions under IRC Section 162; and (3) that Section 280E does not apply to a legally operated marijuana business but instead only applies to illegal “trafficking” operations.

In his opinion for the Tax Court, Judge Goeke noted that Congress has the power to lay and collect income taxes under Article I, Section 8 of the Constitution and the Sixteenth Amendment. Additionally, that the United States Supreme Court has held that any deductions from gross income are a matter of “legislative grace” and can be reduced or expanded in accordance with Congress’ policy objectives. [2]  Section 280E was enacted under Congress’ unquestionable authority to tax income pursuant to the Sixteenth Amendment and is directed at persons who operate a business in violation of federal or state law. Judge Goeke stated that he was unaware—and that the Petitioner had not cited—any cases where the disallowance of a deduction was construed as a penalty. Furthermore, the overwhelming precedent holds that deductions for determining income are a matter purely left to congressional discretion and that the disallowance of a deduction is not a penalty.  Accordingly, the Tax Court held that Section 280E is not a penalty provision and consequently does not violate the Eighth Amendment.

Petitioner’s second argument was based on the fact that the language of Section 280E tracks the business deduction language of IRC Section 162, and therefore, the Petitioner argued that the restriction of Section 280E is limited only to the business expenses deducted under Section 162. Judge Goeke disagreed, finding that the broad language of Section 280E leads to the conclusion that it was written to deny all deductions under any IRC section for a business that trafficked in controlled substances. 

The Petitioner’s third argument was that Section 280E only applies to illegal marijuana activities, based on the use of the word “trafficking” in Section 280E.  Again, Judge Goeke disagreed and cited prior Tax Court precedential cases which held that the sale of medical marijuana pursuant to California law still constituted “trafficking” within the meaning of Section 280E.  Lastly, Judge Goeke advised the Petitioner that the Petitioner’s remedy lies with Congress rather than the U.S. Tax Court because of the language of Section 280E.

Most decisions of the U.S. Tax Court are written in the name of only one judge, so it is worth noting that of the 19 Tax Court judges, the Northern California decision cited: (a) the agreement of nine other Tax Court judges, (b) the non-participation of one other Tax Court judge, (c) two concurring opinions (one agreed to by three judges and the second agreed to by another judge) and (d) a concurring in part and dissenting in part opinion. The fact that this opinion was reviewed by the entire U.S. Tax Court and that there were concurring and dissenting (in part) opinions, makes this decision more significant as legal precedent and indicates the importance that the judges of the U.S. Tax Court see in the Northern California case. 

Dealing with Section 280E is a constant battle for American cannabis companies, as it precludes the ability to deduct most normal business expenses. While thoughtful tax planning may be able to mitigate some of the harms caused by Section 280E, it still undoubtedly leads to reduced profitability and lower market valuations. But all hope is not lost. Northern California will likely be appealed to the Ninth Circuit Court of Appeals, and the dissenting opinions from Judges Gustafson and Copeland may provide a roadmap to further legal challenges to Section 280E. In addition, Congress appears primed to move on significant cannabis reform, including the broad reform efforts captured in the S.T.A.T.E.S Act and more limited reform efforts to address banking and the impact of Section 280E specifically.

[1] Pub. L. No. 91-513, Sec. 202(c) and codified as amended at 21 U.S.C. Section 812(c); see also 21 C.F.R. Section 1308.11(d)(23).

[2] See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1982), and New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).