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The Regulatory Twilight Zone: California Hashish Transactions

For years now, I’ve seen and analyzed many various hashish enterprise relationships throughout the trade spectrum. Particularly, many proposed and draft agreements have come throughout my desk detailing the contractual relationships between quite a lot of events within the hashish trade for varied functions–from buyers, ancillary providers suppliers, and licensees to mental property holding firms, tools lessors, and lenders (and extra). Altogether, I’ve seen a lot of totally different contractual and company set ups inside quite a lot of cannabis-friendly states. California, although. takes the cake on probably the most weird and legally questionable hashish enterprise relationships and contract constructions; and that is sensible as California hashish continues to emerge (form of slowly) from a grey medical market.

In the end, while you consider California’s hashish market at this level, you may 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 lately wrote about all of the unhealthy conduct that also happens in California (even with licensing in play) and likewise about the highest 5 most harmful hashish contracts on this state, however this put up is devoted to these contractual and company relationships and constructions I’ve seen most lately within the Golden State that hold developing time and again. These preparations both skirt the hashish guidelines fully, or make zero sense from a contract and/or company governance standpoint. So, if you happen to’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 permit an unlicensed enterprise to function inside its premises is rising quickly in California. In most different states, the rules make abundantly clear that any firm engaged in business hashish exercise, it doesn’t matter what, would require a hashish license and that you just can’t function an unlicensed hashish enterprise throughout 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 each one business hashish exercise can solely happen between licensees however on the identical 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/via a licensed firm, conducting business hashish exercise as if the unlicensed firm owns the license. (And issues change 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 appearing as, let’s say, a administration firm of that licensed enterprise on the identical 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 increasingly more: 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’ll begin actually analyzing these relationships to find out who is definitely conducting business hashish exercise in violation of the foundations (most likely a lot of people).

2.     Licensee contracts with unlicensed events that function at a licensed facility.  

These sorts of contracts change into more and more difficult due to no 1 above. For those who’re a licensee and also you’re being introduced with a contract from an unlicensed celebration that’s working inside one other firm’s licensed premises, it’s essential 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 endeavor 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 vital regulatory points sooner or later (to not point out murky points round representations and warranties round compliance with the foundations, health of product, remembers, and so forth.).

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 instantly contract with licensed distributors or retailers to get their very own product to market (the place that product, on the identical time, will include the cultivator’s or producer’s data to fulfill the packaging and labeling guidelines, however can be co-branded with the unlicensed firm’s data and mental property). With out extra steerage 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 by no means 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 path, management, and/or administration over the licensee relative to the IP, the unlicensed firm could also be thought of an “proprietor” underneath BCC rules; and which means disclosure of the unlicensed celebration and most scrutiny from the state.

Anybody who’s completed an IP licensing settlement is aware of that the licensor usually will get substantial management over the usage of the IP relative to the licensee, so already we probably 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 challenge 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 constructive that there are IP licensing and white label and provide agreements in California which have created secret homeowners in all places due to the extent of management in these agreements given to unlicensed events. The BCC has little or no steerage out about these relationships, so its scrutiny of those agreements will most likely 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 people, 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 can assist it (which is simpler stated than completed). Specifically with the BCC, if you happen to’re an proprietor that’s an entity, you might be 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 homeowners at 20% or extra AND all people in a management, path, or administration positions, however you’ll additionally disclose all your monetary curiosity holders (with only a few exceptions) which are at 19% or much less in fairness. (And, sure, this contains disclosure of any funding funds or restricted companions in a basic partnership, and each individual or entity inside these constructions, too, if you happen to ask the BCC).

All of that is clearly extraordinarily problematic for fundraising and M&A and plenty of licensees don’t notice that they’ll violate the foundations in the event that they fail to well timed make these disclosures. Regardless of that reality, I see a lot of transactions and cap tables from licensees the place they notice solely when it’s too late that they have to make these sturdy 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 sort of default or obligation round these disclosures — which is an enormous drafting mistake.

5.     Working with no provisional license.

For some motive, some stakeholders are underneath the impression that they’ll proceed to function if they’ve native authorization however no state license. That is simply useless fallacious. And even when you have native authorization and have utilized for an annual license with a purpose 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 a must 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 non permanent licensees that don’t but have provisional or annual licenses. To consumers and/or buyers of hashish firms in California, make it possible for 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 some other state because of the nascent nature of the licensed trade and ambiguities created by the regulators. Sadly, these pitfalls and ambiguities aren’t being addressed with extra steerage and even constant BCC enforcement. In any occasion, proceed with warning on the market and be sure you learn the tremendous print in your proposed agreements and within the guidelines.

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