Tag Archives: court

September 11, 2023

Alternatives to Bankruptcy for Cannabis Companies: Part 3

By Brent Salmons, Yuefan Wang

Part 1 of this series discussed the lack of bankruptcy protections for cannabis companies, since bankruptcy in the U.S. is an exclusively federal procedure and cannabis remains illegal under federal law and proposed a number of alternative options for businesses struggling in the current environment. Part 2 of this series focused on state law receiverships for several states.

In this the third and final part of this series, we continue to review state law receiverships for several additional states and discuss the final non-bankruptcy option for cannabis companies, an assignment for the benefit of creditors.

Below is an overview of the laws and rules governing receiverships in several additional states which have legalized cannabis.

Massachusetts

In Massachusetts, receiverships are governed by statute, with numerous statutes for receivership in various industries and entity types but, in general, the appointment of a receiver is granted by a court after the filing of a complaint by third party, most frequently a secured creditor.

In keeping with its industry specific approach, the state cannabis regulator has enacted rules detailing the steps for a cannabis receivership. Most notable among these rules is a requirement to provide notice to the state regulator at least five days before filing a petition to appoint a receiver and, similar to the approach of Nevada, establishing minimum requirements for a person to serve as a receiver for a cannabis company (which generally require a person to pass a background check and have a crime-free past). In addition, because of the fairly restrictive local licensing in Massachusetts, coordination with the locality in which a cannabis company has operations is also required.

Michigan

Michigan has a broad receivership statute, in addition to both entity and industry specific statutes. The general receivership statute allows for the appointment of receivers as part of a court’s equitable powers so long as the appointment is permitted by law. In 2020, Michigan law was amended to specifically permit receivers to be appointed over cannabis companies. The state cannabis regulator’s rules require notice to such agency within 10 days following the appointment of a receiver, and Michigan law further provides that receivers may only operate a cannabis facility upon approval by the state regulator.

Anyone may seek the appointment of a receiver in Michigan, even if they have a connection to the property or business to be placed in the receivership. However, an action may not be brought solely to appoint a receiver but must instead be sought after an action for another claim has already been made. If a court determines it has cause to appoint a receiver, such receiver must have “sufficient competence, qualifications, and experience to administer the receivership estate”. Receivers in Michigan appointed under the general commercial receivership statute (including receivers over cannabis companies) are subject to the court’s equitable discretion but have broad powers, including the power to operate, restructure, liquidate, and sell the business.

Missouri

Like Michigan, Missouri has a general receivership statute as well as statutes for specific receivership situations, notably with respect to corporations. However, Missouri has not enacted any particular rules with respect to cannabis companies and as a result receiverships in Missouri have been conducted under the general receivership statute.

Receivers in Missouri are appointed by a court order following the application of a person with an interest in the assets over which the receivership is sought and an appointment may be made prior to any judgement having been rendered. In addition, the appointment of a receiver may be sought as an independent claim and not as an ancillary claim to another primary claim. Receivers may be granted powers as a general receiver (similar to “equity receivers” in other states) with powers over all of the assets of a debtor, or over specific property of a debtor.

Missouri’s cannabis regulations contain very few rules that specifically relate to a receivership, other than a requirement to provide notice to the state cannabis regulator within 5 days of a receivership filing. While some parties have cited a lack of cannabis specific rules as creating a lack of clarity regarding receivership in these states, Missouri courts and the state regulator appear to be applying the general receivership rules to the industry with at least one receivership in the state in the final stages of completion.

Assignments for the Benefit of Creditors

To conclude this series, we want to revisit another option we discussed in Part 1 for dealing with a financially troubled firm: an assignment for the benefit of creditors (ABC). While voluntary negotiations with creditors is typically taken where the value of the underlying business clearly exceeds the liabilities of the business, and receivership is an avenue for creditors to seek a court to force a restructuring or liquidation of a business, even over the objections of the business itself, an ABC process can be appealing where the creditor and debtor maintain relatively amicable relations, but the value of the business is such that it is clear the equity holders have little to no value remaining in the business. A creditor may view the ABC process, which is generally a lower cost option as compared with a court-supervised receivership, as the superior proposition in these circumstances.

An ABC is a state common law or statutory remedy available to debtors that is roughly analogous to a Chapter 7 bankruptcy or liquidating Chapter 11 bankruptcy. Unlike a receivership, where a creditor applies to a court for the appointment of a receiver and such an appointment can be granted even over the objection of the debtor, an ABC is a step taken by the debtor itself to liquidate its assets in an orderly fashion with the proceeds paid to its creditors. While courts can be involved to resolve specific matters, and ABC process is principally undertaken without court involvement or direct supervision.

Unlike a receivership, an ABC is a step taken by the debtor itself to liquidate its assets in an orderly fashion with the proceeds paid to its creditorsTo initiate an ABC process, the debtor selects the assignee to take ownership of its assets and such assignee holds such assets in the functional equivalent of a trust for the benefit of the creditors of the debtor. As such, the assignee, while selected by the debtor, owes duties (typically fiduciary duties under state law) to the body of creditors.

Once the assignment has occurred, the assignee will engage in a relatively significant diligence effort in order to gain a clear understanding of the assets and liabilities of the debtor, to complete the assignment and to provide notice to third parties and creditors of the fact that the assignment has occurred. The assignee then generally oversees the operation of the business (if it is continuing) while moving to create a sale process for its assets, whether through some sort of public auction or a privately negotiated sale (which, as in bankruptcy proceedings, may include stalking horse bids).

One notable difference between the bankruptcy and receivership process and an ABC is that, in general, assets sold in an ABC are not sold free and clear of all underlying liens, meaning that senior secured creditors must consent to any sale, or their liens will travel with the assets.

While ABCs offer many advantages over receiverships, including a typically lower cost, flexibility in the selection of the assignee, and a generally easier and faster path to liquidation of assets, there are limitations, including the risk that a third party may seek to appoint a receiver after an ABC has been commenced or that the compensation package granted the assignee is disproportionately high, each of which could ultimately result in higher costs for all involved. Furthermore, sales of assets in an ABC are not automatically sold free and clear of all liens.

In the end, regardless of where a cannabis company may be operating, the lack of access to federal bankruptcy courts does not deprive the company or its creditors of viable avenues to restructure or liquidate a business. However, because these options are less familiar to those who typically operate in the bankruptcy-centric restructuring arena in other industries, companies and creditors in the cannabis space are well advised to consult with counsel familiar with the cannabis industry and the restructuring alternatives that remain available to them.

September 1, 2023

Alternatives to Bankruptcy for Cannabis Companies: Part 2

By Brent Salmons, Yuefan Wang

No Comments

Background

A cannabis operation facing financial difficulties may try to avail itself, on the one hand, of the contractual remedies described in Part 1 of this series, but these remedies may be flimsy given their narrow scope and reliance on voluntary negotiation between parties whose relationship is already likely tense; on the other hand, the statutory remedies described in Part 1 of this series may be too rigid and absolute, necessitating the disposition of a business as a collection of assets, instead of its continued operation as a going concern. An alternative is receivership, a flexible but powerful quasi-judicial approach paralleling federal bankruptcy able to be administered by state courts. Compared to federal bankruptcy, state receivership is both over and under-inclusive: while receivership can be used in many more situations than insolvency, such as a financially healthy business that is nonetheless subject to regulatory action, receivership provides less comprehensive protection for an insolvent business.

Receiverships have their roots in English and Welsh courts of equity, which were seen as offering fairer remedies than their contemporary common law courts, bound as they were by ponderous precedent. In contrast, courts of equity had more discretion to apply remedies which could be more tailored and “equitable” to an individual petitioner, even if such remedies were not codified. While this separation of equitable and common law courts does not generally exist in the modern U.S. legal system (except for a few hold-out states, most notably, Delaware), the legacy remains in the type of civil remedy available: while most remedies are awarded as monetary redress for a past wrong suffered by a plaintiff (e.g. liquidated damages for the discloser of confidential information or the “benefit of the bargain” for the seller of a company), equitable remedies often require prospective action (or forbearance of an action) by the defendant (e.g. an injunction on disclosure by a recipient of confidential information or specific performance by a purchaser of a company). To draw the analogy out, bankruptcy is a “legal” process to address insolvency since it is governed by a comprehensive regime of federal statutes and rules in the Bankruptcy Code (which is, ironically, applied by specialized federal courts), while receivership is the “equitable” side of the same coin: a judicially-created remedy to manage or liquidate a business, among other actions, where it would not be equitable (or, most importantly for cannabis businesses, not possible) for a bankruptcy action.

Some states with legalized cannabis have cannabis-specific receivership statutes, usually providing that the receiver either be temporarily or fully licensed similar to any other operator of a cannabis business.As an equitable remedy used by various states and federal entities, generalizations about the receivership process are difficult to make. However, broadly speaking, a typical receivership process begins with a complaint filed against the entity for which receivership is sought in state court. This filing can be made by a variety of parties outside of the standard debtor-creditor relationship (reflecting the equitable nature of receiverships), including by regulators and disputing owners of a business. After this filing, a motion to appoint the receiver (which is usually but not always a third party) is filed with the court; consent of the opposing party is generally not required in appointing a receiver but can often make the process easier. The complainant must then establish standing and the occurrence of certain events, including insolvency, but also mismanagement of a corporation or a foreclosure. The requirements of such events are fact-specific and may often be governed by statute or the contractual relationship between parties. The order appointing the receiver usually sets out the specific powers the receiver has in any given case to oversee the disposition or operation of the assets subject to the receivership (called the “receivership estate”) for the benefit of its’s creditors.

Receivership laws generally fall into two categories: some states provide for a broad general statute, sometimes accompanied by statutes specific to industries which are heavily regulated, entity types, or process, while in other states the power is an extension of the court’s powers, set forth in the state’s rules of civil procedure. States also differ as to whether a receivership is considered an independent remedy, a standalone legal action which can be pursued in and of itself (e.g. a petition by a creditor to appoint a receiver to resolve settle an unpaid debt), or an ancillary remedy, a legal action that supports a primary claim (e.g. a request to appoint a receiver in connection with a dispute over the ownership of a business). Some states provide for general receiverships, which allows receivers to take control of an entire business, while other states also allow limited receiverships, which allows the receiver take control of a portion of a business, while the owner operates the remainder. Some states with legalized cannabis have cannabis-specific receivership statutes, usually providing that the receiver either be temporarily or fully licensed similar to any other operator of a cannabis business.¹

Below is an overview of the laws and rules governing receiverships in certain states which have legalized cannabis.

Arizona
In Arizona, receivership is governed by statute, with a general statute and specific statutes for certain industries and type of receivership. Arizona law recognizes that principles of equity apply to all matters relating to receivers, providing the court overseeing the receivership with additional power to decide the remedies available to the receiver. In addition, Arizona has enacted a specific statutory framework for the appointment of receivers for commercial real property and personal property related to or used in operating the real property. Arizona also uses a separate receivership statute to provide for corporate dissolution receiverships, in which a court in a judicial corporate dissolution proceeding may appoint one or more receivers to wind-up, liquidate, or manage the business and affairs of the corporation.

There are no specific statutes governing receiverships of cannabis businesses, so the general receivership statute applies to cannabis businesses, subject to Arizona’s rules governing the operation of a cannabis business. For example, Arizona cannabis regulations that require anyone volunteering or working at a medical or recreational cannabis dispensary to be registered with the cannabis regulator similarly apply to a receiver appointed over a licensed cannabis business.

California

California does not have significant entity-specific or industry-specific statutes for receiverships; rather a California court’s power to appoint a receiver is granted under the state’s rules of civil procedure. Receiverships in California are solely an ancillary remedy; a receivership is commenced once a complaint is filed and any party to the action may seek to appoint a receiver. Circumstances that allow for the appointment of a receiver are fact-specific and at the discretion of a judge, although contractual provisions for the appointment of a receiver are given weight under the rules. Sales of assets in the receivership estate must be submitted to, and approved by, the appointing court.

While the rules of civil procedure provide for the general powers of a receiver, the specific powers a receiver possesses in any given case is granted by the judicial order appointing the receiver; this appointment order is therefore, along with the court itself, the primary authority for the parties in any given receivership. California explicitly disqualifies certain persons, such as parties to the lawsuit, an attorney of a party, a person interested in an action, or any person related to any judge of the court within the third degree, as receivers.

While California’s receivership rules do not explicitly contemplate cannabis businesses, receiverships for cannabis companies have taken place, but in our experience are less common in California than assignments for the benefit of creditors (which we will address in a later article). Like other licensed businesses in California, cannabis companies must provide notice to the state regulatory agency which granted the license. It is up to the agency’s discretion whether the business may be operated under the existing license or whether the receiver must secure a new or temporary license.

Colorado

Like California, no generally applicable receivership statute exists in Colorado; instead, receiverships are governed by the state’s rules of civil procedure. Under these rules, a receiver can be appointed under a court’s general equitable powers. Appointment of a receiver is an independent remedy in Colorado, but is contingent on a lawsuit having commenced and the court having deemed the receivership as necessary and proper. In addition to the court’s general equitable powers to appoint a receiver, and unlike California, Colorado has receivership statutes that are entity and industry specific. The entity-specific statutes permit the appointment of a receiver for the judicial dissolution of for-profit corporations, non-profit corporations, limited liability companies, and cooperatives, and the industry-specific statutes permit the appointment of a receiver for the windup of failed insurance companies and the closure of long-term care facilities.

Similar to California, the court order appointing a receiver governs the entire receivership process and any disposition of the assets of the receivership estate must be submitted to and approved by the court.

As befitting the first state to legalize adult-use cannabis, Colorado’s cannabis regulations specifically address receiverships: the rules create a notice and application requirement for all court appointees, including receiverships, and require receivers to register with the regulator as a “temporary appointee” of the court.

Illinois

Illinois does not have a comprehensive receivership statute; instead, the state has industry-specific statutes, including for regulated industries such as nursing home facilities and telecommunication carriers. Illinois also provides for “equity receiverships”, which are used as an ancillary remedy in business disputes in order to stabilize a business that is adversely affected by fraud, neglect, waste, dissipation, or other misconduct during the pendency of the underlying proceeding. If the underlying matter is within the general or statutory jurisdiction of the court, then such court has jurisdiction over the receivership.

There are no specific statutes governing receiverships of cannabis businesses, but the governing statute does contemplate operation of a cannabis business by a receiver, so regulations promulgated thereunder should apply to receivers as well, including with respect to licensing.

Maryland

Adult-use cannabis sales only began in Maryland July 1, 2023. Maryland has a general receivership statute.

Receivers in Maryland are generally appointed by the person seeking appointment, including the court, and must meet certain qualifications, such as not having any material financial interest in the outcome of the receivership, and not having any debtor-creditor relationship with or equity interest in any party to the receivership. While the general receivership statute provides for broad powers of the receiver, including general management of receivership property, hiring professionals, and issuing subpoenas, the court may modify or expand the powers of the receiver via the appointment order.

While there is no cannabis-specific receivership statute, Maryland’s medical cannabis rules contemplate and authorize the transfer of licenses to a receivership; similar rules have been proposed for adult-use cannabis licenses as well.

Nevada

Nevada has a broad receivership statute, in addition to both entity and industry specific statutes. Case law is not well-developed and mostly predates the current statutory scheme, but there is support for a receiver being appointed outside of a statutory context, specifically when the situation is governed by contractual agreement.

The general receivership statute provides that a receiver may be appointed in a variety of situations, such as fraudulent property purchases, foreclosure of mortgages, or the dissolution or insolvency of a corporation.

Nevada has a statutory regime for receiverships for cannabis companies. Unlike the general statute, there are significant requirements for who can be a receiver for a cannabis business. A receiver must first secure a cannabis establishment agent registration card for a cannabis receiver issued by Nevada’s cannabis regulator. In addition, the receiver must submit an application to the regulator accompanied by, among other requirements, a statement saying the receiver has not previously had an agent registration card revoked. The receiver must also provide proof that she has (1) experience or knowledge of the cannabis industry, (2) experience as a receiver appointed by a court, (3) knowledge and skills necessary to make reasonable financial decisions, and (4) adequate financial capacity to fulfill the duties of a receiver. If the regulator is satisfied with the receiver’s application, it will issue the receiver an agent registration card which must be renewed two years after issuance. It is worth noting that Nevada’s statute governing the non-transferability of certain agent registration cards for cannabis allows the regulator to adopt regulations that give priority in the processing of transfers of licenses for transferors subject to receivership. To date, however, no such regulations allowing priority for receivership processing have been adopted.

Washington

Washington has a general receivership statute, but not any entity or industry-specific receivership statutes. Washington’s receivership structure with overhauled in 2004 with the passage of a new law, so it is not completely settled whether receivership is now an independent or ancillary remedy; however, the language of the statute language suggests that it is an independent remedy.

To be appointed a receiver in Washington, the individual must meet certain requirements, including not being a party to, or be closely controlled by a party to, the underlying action and not having materially adverse interest to the person against whom receivership is sought. The general statute specifically outlines the powers of the receiver. Certain actions by the receiver require court approval before being finalized, including the assumption or rejection of executory contracts, and sales of property outside the ordinary course of business.

Washington law specifically provides for receiverships for cannabis companies. To be a receiver, the person must satisfy the requirements of Washington’s receivership law, and either be preapproved by the cannabis regulator or else be approved post-application. In order to qualify for the regulator’s preapproved receiver list, or be approved post-application, the putative receiver must (1) submit an application, (2) have been a Washington resident for at least six months prior to submission, (3) submit to and pass a criminal background check, (4) provide financial disclosures as requested by the regulator, and (5) disclose any interests in the cannabis licensees. Once a person is appointed as receiver for a cannabis licensee, she shall not have a financial interest in, or simultaneously serve as receiver for, another licensed cannabis retailer. The receiver may not also serve as a receiver for, or be a party of interest in, more than five cannabis retail licensees or more than three cannabis producer and/or processor licensees at the same time. Finally, any person who files a receivership action involving a cannabis licensee must provide notice to the regulator.

Part 3 of this series on Alternatives to Bankruptcy for Cannabis Companies continue our review of receivership in various states and other bankruptcy alternatives, including assignments for the benefit of creditors.

Reference

As cannabis legalization continues to spread, more robust industry-specific receivership rules may be promising given the heavily regulated and specialized nature of the business, similar to how a number of states have industry-specific rules for other heavily regulated industries.

June 21, 2023

The Distressed Cannabis Business: An Alternative to Bankruptcy

By Paula Durham, Scott E. Evans

No Comments

Bankruptcy is Not an Option

Bankruptcy courts do not provide protection to cannabis and cannabis-related businesses.Bankruptcy can be a very helpful tool for a distressed business. Bankruptcy allows a business to stop collection actions, discharge certain debts, cancel unfavorable contracts and provides breathing room to restructure the business.

What if your cannabis operation is struggling or failing – file for bankruptcy, right? Not so fast. Despite cannabis being legalized or decriminalized for certain activities at the state level, it remains illegal at the federal level. Therefore, the bankruptcy court will not provide protection to cannabis and cannabis-related businesses (CRB).

Alternatives to Bankruptcy

A State Court receiver may be the best alternative when bankruptcy is not an option.Enter the state court receivership. Receivership is an equitable remedy that is often employed as an alternative to a bankruptcy proceeding. A receivership can address business insolvency or can be a temporary remedy during legal proceedings between disputing business partners, with control of the enterprise hanging in the balance.

In either scenario, the court appointed receiver takes control of the business and must assess the posture of the business and determine the best path forward. The receiver’s options run the gamut from operating the company as is, restructuring operations to maximize profit or closing shop and liquidating the business as a whole or in pieces. The receiver has a fiduciary responsibility to determine the option that best satisfies creditors, similar to duties required of a trustee in a bankruptcy.

The importance of having a receiver well-versed in the cannabis industry cannot be overstated.Distressed cannabis companies are often prime candidates for receivership. Cannabis is a burgeoning industry with huge growth and profit potential. However, worlds have collided in the Green Rush, where business-minded individuals, often with little knowledge of cannabis, have partnered with individuals well-versed in cannabis culture, cultivation and consumption, but with little experience operating a business. Add a dash of complex state laws and regulatory drama in the form of the federal/state divide on legality, a dollop of fraud potential due to the largely all-cash nature of the business and you’ve created the perfect recipe for insolvency, litigation or both. In these often-chaotic conditions it is easy for a cannabis company to become unprofitable. A receiver can add significant value by stabilizing the business while the litigation proceeds or while developing a restructuring plan. In either case the goal of a receivership is to maximize the value of a business for the benefit of its stakeholders.

If you are considering restructuring options for your cannabis operation, a receivership can be an excellent choice. However, a cannabis receivership is not for the faint of heart. There are two significant areas that distinguish cannabis receiverships from receiverships involving non-cannabis businesses: First, the complex regulatory environment and second, banking. The importance of having a receiver well-versed in the cannabis industry cannot be overstated. Making a mistake in these areas can cause more harm than good.

Complex Regulatory Environment

Cannabis operations are subject to a complicated regulatory framework that varies by state as well as by type of legalization (medical versus adult use cannabis). Receivers unfamiliar with the cannabis industry and the associated regulatory framework will be behind the curve on day one.

Upon appointment over a cannabis entity a receiver becomes responsible for the regulatory posture of that entity.Regulatory hurdles begin at the outset of a receivership. Although receivership is an excellent restructuring option for cannabis operators in distress, regulations surrounding the authorization requirements for those operating the business on a day-to-day basis (including receivers) vary by state. Some states, but not all, even have specific regulations for receiverships.

For example, the rules and regulations for cannabis operators in Colorado administered by the Colorado Marijuana Enforcement Division (MED) include provisions for receiverships. Specifically, the MED requires court appointees, including receivers, to register with the State Licensing Authority as Temporary Appointee[s] of the Court within seven days of appointment.

Similarly, Washington State cannabis regulations directly address receiverships. Specifically, Title 314 allows receivers or trustees to operate a licensed cannabis business, but the receiver must be qualified by the Washington State Liquor Control Board (LCB). Qualification requirements include active status on the LCB preapproved receiver list or submission of an application to serve as a receiver for a licensee within two days of appointment. Furthermore, to serve as a receiver of a Washington state cannabis licensee the receiver must meet residency requirements.

Conversely, the Arizona cannabis laws and rules do not specifically address cannabis receiverships. Nevertheless, Arizona does require anyone volunteering or working at a medical or recreational cannabis dispensary to be registered with the Arizona Department of Health Services as either a Dispensary Agent (DA) or a Facility Agent (FA). Therefore, a receiver appointed over a licensed cannabis business in Arizona must obtain the applicable registration upon appointment in order to take control of the licensed entity in a compliant manner.

The fun doesn’t stop after the initial appointment hurdles are cleared. The regulatory environment across the country is a patchwork of complex laws. States that have legalized or decriminalized cannabis on some level have instituted often complex rules surrounding the cultivation, manufacture, wholesale and retail sale of cannabis. Even seemingly simple concepts such as the definition of cannabis are not so simple in some states. For example, Massachusetts includes cannabidiol (CBD) in its definition of cannabis while Arizona does not.

Some states, like California, do not allow the sale of cannabis licenses. Other states, like Colorado, allow for the transfer of commercial cannabis licenses. In a turnaround situation it is particularly important to understand the options available to liquidate a licensee’s assets.

Similarly, many, but not all states have rules requiring cannabis product testing by accredited laboratories prior to retail sale. Most states require THC potency testing, while others (like California and Colorado) also require testing for pesticides and toxins. Conversely, testing for toxins and contaminates is voluntary in Florida. Product testing is expensive and time-consuming, and operators must have a comprehensive system in place to ensure compliant product is available for sale to retail and wholesale customers.

Even taxes are different for cannabis businesses. A receiver must understand and be able to manage a cannabis business in order to comply with and minimize taxes under the infamous 280e regulations of the U.S. tax code.

Upon appointment over a cannabis entity a receiver becomes responsible for the regulatory posture of that entity. Accordingly, the receiver must ensure that any regulatory deficiencies are identified and corrected in order to ensure compliant operation.

We’ve highlighted just a few of the myriad of regulatory concerns facing a receiver upon appointment. It is critical to engage a receiver who has experience working under the complex cannabis regulatory structure for your distressed cannabis operation.

Banking

One of the most important things a receiver does upon appointment is to identify and secure the assets of the entity in receivership, including cash. This normally involves opening a bank account in the name of the receivership entity that is controlled solely by the receiver and moving cash assets into the controlled account.

This typically ordinary task is not so easy with a cannabis operation. Because cannabis remains illegal under federal law, processing funds derived from the sale of cannabis (even sales that are legal at the state level) can be considered by the Department of Justice (DOJ) as aiding and abetting criminal activity or money laundering.A receiver must negotiate the complex banking regulations regarding cannabis businesses and effectively manage the large amounts of cash, which may not be bankable.

The Financial Crimes Enforcement Network (FinCen) issued guidance in 2014 that cleared the way for financial institutions to service canna-businesses (2014 Guidance). The 2014 Guidance requires financial institutions who choose to provide services to CRBs to design and implement a thorough customer due diligence review that includes, in part, analyzing the licensing of the entity, developing an understanding of the business operations of the entity, and ongoing monitoring of the entity. In addition, financial institutions are required to file a Suspicious Activity Report (SAR) for every transaction they process for a CRB, should they choose to accept the business.

While this is a positive step forward, it is a heavy compliance burden that comes at a cost. Naturally, compliance costs incurred by banks to service cannabis operators are passed on to the customer; fees of $2,500 per month per account are not uncommon. The high compliance costs, coupled with the significant regulatory risk, keeps most banks out of the cannabis market; thus, making it hard, but not impossible, for a receiver appointed over a cannabis operation or CRB to obtain banking.

While banking options do exist, the reality is that most canna-businesses operate on a cash basis. Distressed cannabis operations may not have the cashflow to afford banking services, at least at the outset of a receivership. Further compounding the banking problem, some banks that are open to cannabis are not open to receiverships, further limiting banking options.

A receiver therefore must be prepared to quickly secure all cash assets of the receivership entity and ensure appropriate internal controls are in place to control cash on an ongoing basis.

Cannabis has been legalized or decriminalized in a majority of U.S. states but remains illegal at the federal level. Therefore, federal bankruptcy protection is not generally an option available for a distressed canna business. However, not all is lost because state receiverships offer an excellent restructuring option for distressed cannabis operations.

July 20, 2022

Cannabis Receiverships: A Viable Alternative to Bankruptcy

By Oren Bitan

No Comments

Doing business in California’s legal cannabis industry remains a risky endeavor. The majority of the industry is still unlicensed, tax rates at the state and local levels are high (notwithstanding a recent reprieve from California’s cultivation tax) and there are not enough licenses to meet geographic demand throughout the state. Outside financing remains difficult to secure for equipment, tenant improvements, account receivables and working capital because, under the federal Controlled Substances Act (CSA), cannabis remains a Schedule I narcotic. Therefore, entrepreneurs, investors and lenders who have stakes in state-sanctioned cannabis enterprises expect to see returns that justify the higher level of risk, which places additional financial pressure on cannabis businesses. In addition to the industry specific challenges, the United States economy is on the verge of a recession that may further hamper the industry notwithstanding the industry’s resiliency during the pandemic when it was deemed to be an “essential” industry that benefited from consumer spending of stimulus monies.

These outside pressures increasingly lead to ownership disputes and creditor defaults that result in litigation and the need for restructuring. In some instances, business partners cannot agree about control and finances of the licensed businesses and in other instances unpaid creditors file suit to enforce their interest in a company’s assets. And sometimes a local municipality discovers wrongdoing by an operator and initiates a health and safety lawsuit to cease the illegal condition.

Bankruptcy reorganization is an option typically utilized by struggling businesses to shed or restructure debt. Cannabis businesses, however, cannot take advantage of bankruptcy remedies because bankruptcy is a product of federal law and federal law still prohibits the sale of cannabis.

As a result, stakeholders in legal California cannabis enterprises must consider alternatives to bankruptcy to collect what they can on their loans and investments in the event the enterprise becomes insolvent or requires restructuring. A well-established alternative to bankruptcy is a state court remedy – the appointment of a receiver over the assets of a business or over the entire business operations. Through the receivership process, stakeholders may obtain many of the same protections available to them through bankruptcy

A. Federal Illegality Bars Access to Bankruptcy Protection

Over the past ten years, bankruptcy courts have routinely prohibited licensed cannabis businesses from seeking bankruptcy protection because cannabis remains illegal at the federal level under the Controlled Substances Act (CSA). Bankruptcy trustees are typically charged with managing and operating property in the same manner that the owner would be bound to do if in possession thereof. Because cannabis remains illegal at the federal level, trustees are not able to manage and operate licensed cannabis businesses.

B. Receivership as an Alternative to Bankruptcy

Under California law, a receiver is a neutral agent of the court appointed to preserve, control, manage and ultimately dispose of property that is subject to the litigation before the court.¹ The receiver, therefore, holds property for the court, not the parties to the litigation.

Appointment of a receiver is a statutory provisional remedy. Other than corporate dissolutions under Code of Civil Procedure section 565, the law does not have a specific cause of action to appoint a receiver. Thus, the proponent of a receiver must have a valid cause of action in an underlying lawsuit.

1. The Appointment of a Receiver

The appointment of a receiver rests within the trial court’s discretion. Code of Civil Procedure section 564 contains the broadest statutory authority to appoint a receiver. Subdivision (b), details twelve possible situations in which a receiver may be appointed, most of which are beyond the scope of this article. The most common of these is a lender’s request to appoint a receiver when a borrower defaults on a loan and the lender seeks the appointment of a receiver over its collateral. The statute, however, clarifies that the situations listed in the statute are not exclusive: a court may appoint a receiver “[i]n all other cases where necessary to preserve the property or rights of any party.”

The receiver’s powers are limited by the statute under which the court appointed the receiver and those conferred by the court. The appointment order should, therefore, detail the duties the receiver owes to the court, and actions that the court authorizes the receiver to take to perform those tasks. The order should also specify the property that will be part of the receivership estate.

2. The Receiver’s Powers

The receiver has general statutory powers.² The statutory powers include (i) commencing or defending litigation; (ii) taking and possessing property of the receivership estate, (iii) receiving rent, collecting debts, and making transfers, and (iv) acting in accordance with the court’s instruction with respect to the property.³ But the court’s authorization is necessary to sue the receiver and for the receiver to commence litigation.⁴ In the foregoing scenarios, the receiver is immunized personally from tort liability, but not in his or her official capacity as receiver.⁵

In addition to taking possession of property, the receiver may dispose of receivership property with the court’s approval.⁶ If the receiver is an equity receiver, the receiver may take possession and satisfy creditors from all the debtor’s assets.⁷

The court may further authorize the receiver to issue “certificates of indebtedness” to raise money to administer the receivership estate.⁸ This device permits the receiver to provide liquidity to the estate and gives the certificate holder an interest-bearing priority claim against the receivership estate.

3. Liquidating Cannabis Assets Through a Court Appointed Receiver

After the court appoints the receiver, the receiver should have sufficient powers to, among other things: (i) take over the management of the company; (ii) open bank accounts; (iii) borrow money by issuing receivership certificates; (iv) manage all of the company’s property; (v) hire counsel and other professionals; and (vi) sell the receivership estate’s assets for the benefit of the creditors. To maximize repayment to the creditors, the receiver may hold an auction to sell the assets and assist in facilitating the cancellation of company’s state license while the buyer of the assets secures its state license after the local license is transferred.

State cannabis licenses may not be sold or transferred.⁹ Yet, to maximize recovery for the creditors, the receiver may need to participate in the regulatory process to maintain a license during the pendency of the receivership and to assist in the amendment of a license while a prospective buyer seeks to obtain its own license. To do so, the receiver will first need to qualify as a licensee under state law to join as a licensee on the license and further the licensee as a going concern. Next, the principals of the prospective buyer will themselves need to qualify as licensees under the license. Then, once the sale of the company’s assets (including any interest in the license) to the buyer closes, the receiver and the company’s original owners will terminate their capacities as licensees of the license, leaving only the new owners as licensees. Thus, the proposed order should be written with attention to ensure the receiver has powers to further the foregoing and not diminish the value of the receivership estate.

After the conclusion of the sale of all assets, the receiver will need to obtain a discharge from the court of his or her duties as receiver. The receiver may do so by the parties’ stipulation or by motion. Together with the request for a discharge, the receiver should seek approval to pay: (i) any lenders to the receivership estate; (ii) professionals that the receiver hired; and (iii) him or herself for his or her services. Upon the court’s approval, the receivership will be terminated.

The conflict between federal and California law regarding cannabis continues to be an impediment for stakeholders in California’s cannabis market. Because of this conflict, stakeholders in California’s legal cannabis market lack access to vital traditional institutions, such as bankruptcy remedies. As a result, stakeholders must be prepared to consider alternatives such as a court appointed receiver, which can be a useful alternative to both secured creditors and unsecured creditors. Stakeholders who pursue a court appointed receiver will benefit from a long-established body of law and experienced professionals.

References

Cal. Rules of Ct., r. 3.1179(a).
Cal. Civ. Proc. Code §§ 568-570.
Free Gold Mining Co. v. Spiers, 136 Cal. 484, 486 (1902); Steinberg v. Goldstein, 129 Cal. App. 2d 682, 685 (1954).
Vitug v. Griffin, 214 Cal. App. 3d 488, 493 (1989).
Chiesur v. Superior Court, 76 Cal. App. 2d 198, 201 (1946).
Helvey v. U.S. Bldg. & Loan Ass’n, 81 Cal. App. 2d 647, 650 (1947).
Turner v. Superior Court, 72 Cal. App. 3d 804, 812 (1977).
Cal. Civ. Proc. Code § 568.
See e.g., Cal. Code Regs. tit. 16, § 5023(c).

June 22, 2022

Pennsylvania Recall Overturned by State Courts

By Cannabis Industry Journal Staff

No Comments

Back in December of 2021, The Pennsylvania Department of Health sent emails to registered medical cannabis patients, notifying them of a safety review being conducted on ingredients found in cannabis vape products.

Then in February this year, the state’s health agency sent a third email. This one notified patients that they were recalling more than 650 products and ingredients. “As you know, the Department recently conducted a statewide review of all vaporized medical marijuana products containing added ingredients,” reads the email to patients. “After finishing this review, the Department has determined that certain vaporized medical marijuana products containing some added ingredients have not been approved for inhalation by the United States Food and Drug Administration (FDA).”

The recall generated a lot of controversy for the state’s medical cannabis market, leaving patients, dispensaries, processors and other cannabis businesses with little guidance from the state’s health department. Cannabis companies in Pennsylvania, like Curaleaf, Jushi and Trulieve, formed a coalition and sued the state’s health department in February, alleging that regulators ordered the recall preemptively and did so without going through the proper channels, according to the Philadelphia Inquirer.

On June 2, the coalition of cannabis companies won and a judge stopped the recall. The very next day, the health department took issue with the judge’s decision and filed an appeal with the PA Supreme Court. For now though, as the appeal makes its way to Pennsylvania’s top court, the recall is lifted and dispensaries can restock their shelves with vape products.

April 18, 2022

How to Navigate Section 280E: Lessons Businesses Can Learn from Recent Court Outcomes

By Jay Jerose

No Comments

The cannabis business landscape is complex and is under constant review and control. Further, rules and regulations from both federal and state governments can pose additional challenges and barriers to business owners. For those unfamiliar, there is a section of Internal Revenue Code, Section 280E, that prohibits taxpayers who are engaged in the business of buying and selling certain controlled substances from deducting many typical business expenses that other businesses are able to freely deduct.

What is Section 280E and What Challenges Does it Pose?

A dispensary could deduct the cost of the product it sells, but due to Section 280E it would be unable to deduct necessary and ordinary business expenses such as building rent, insurance or employee wages. This can create a significant tax burden, as taxable income is calculated at the gross profit level instead of starting with net income. As a result, Section 280E has become increasingly relevant for cannabis businesses, which have grown substantially in recent years due to more states opting to legalize marijuana. But despite this trend towards legalization at the state level, cannabis with more than 0.3% THC remains illegal under federal law, which raises questions surrounding Section 280E.

In this article, we take a closer look at recent court cases that highlight challenges with Section 280E, the related outcomes and what it means for businesses in the cannabis space.

Challenging its Constitutionality

Patients Mutual Assistance Collective Corp. v. Commissioner, also known as the Harborside Case, partially involved legal arguments against the constitutionality of Section 280E under the 16^th amendment. Harborside argued that income must be present for the IRS to levy an income tax, however Section 280E can frequently cause taxpayers to experience real losses along with taxable income. They argued that they were forced to pay taxes while losing money.

Two circuit courts before this case upheld that Section 280E did not violate either the 8^th or 16^th amendments to the constitution, leading to the court declining to even address the constitutionality claim. The court addressing a constitutionality issue could lead to unintended consequences for unrelated code provisions, leading this strategy to likely fail due to the mess it could unravel.

Attracting Customers with Freebies

Olive v. Commissioner involved a medical cannabis dispensary that also operated a consumption lounge. While the consumption lounge revenue entirely consisted of sales of medical cannabis, the business also provided services such as health counseling, movies, yoga, massage therapy and beverages at no additional cost. The business attempted to deduct the expenses of these free services as well as the cost of the cannabis itself.

The IRS denied the deductions for the additional services due to the sole source of revenue coming from cannabis sales. The court held that the expenses related to free services were designed to benefit and promote the sales of cannabis and induce further business from its customers.

The court did acknowledge that expenses can be allocated between two separate trades or businesses while still complying with 280E. However, distinct revenue streams need to be established to show the clear separability of the activities and care must be taken to document and support the expense allocations.

Co-mingling Cannabis and Non-Cannabis Enterprises

In the case of Alternative Healthcare Advocates v. Commissioner, the owner of a retail dispensary established a separate management corporation to provide management functions to the dispensary business. The two businesses shared identical ownership, and the management company solely provided services to the joint owner’s dispensary. The management company hired employees, advertised, and handled rent and other regular business expenses on behalf of the dispensary.

Despite the argument from the taxpayer that the businesses were separate entities, and that the management company did not own or “touch” cannabis in any way, the Tax Court ruled that both companies were in the business of trafficking illegal substances. This disallowed expenses on both entities. The IRS argued successfully that the operations of both companies were intertwined. The fact that the management company broke even on expenses and provided no services to any other unrelated entities meant that while legally separate, they were considered part and parcel to each other.

The Solution: Clear Documentation, Allocation and Separation

Californians Helping to Alleviate Med. Problems, Inc. v. Commissioner (CHAMP) involved a public benefit corporation that provided caregiving services along with cannabis to customers suffering from diseases. In this case, the taxpayer argued that they had two separate and distinct lines of service, being the sale of cannabis, and the sale of caregiving services.

While the IRS disagreed with this position and attempted to apply Section 280E to the entire entity, the Tax Court disagreed. It held that the taxpayer was operating with a dual purpose, the primary being the caregiving services, and the secondary being the sale of medical cannabis. The taxpayer’s customers were required to pay a membership fee and received extensive caregiving services, including support groups, one-on-one counseling, addiction counseling services, hygiene supplies and even food for low-income members. While the membership fee did include a set amount of medical cannabis, it was not unlimited. The Court held that the taxpayer’s extensive records and documentation clearly demonstrated two separate and distinct lines of business, with the caregiving being a primary service and the medical cannabis being secondary.

From these court cases and outcomes, it is clear that Section 280E can be confusing. The cannabis industry is a high-risk area, and the IRS has successful court cases to stand behind to back their legislation and agenda. These cases demonstrate two very simple concepts: first, businesses have attempted many creative ways of sidestepping Section 280E and failed; and second, clear documentation and detailed financial records are key, and will be paramount to support any tax positions related to Section 280E.

With the risks associated with conducting business in the cannabis industry, there is a strong likelihood that it will be high on the IRS’ radar over the next few years. Cannabis businesses should carefully consider their interpretation and application of Section 280E as it relates to the costs within their business. It will be important for businesses to utilize and consult with experienced attorneys and cannabis accountants to ensure they not only maintain compliance with federal laws, but also keep up with the changing regulations and court test opinions.

Disclaimer: The summary information presented in this article should not be considered legal advice or counsel and does not create an attorney-client relationship between the author and the reader. If the reader of this has legal questions, it is recommended they consult with their attorney.

December 16, 2020

The 2020 Global Cannabis Regulatory Roundup

By Marguerite Arnold

1 Comment

As a strange year heads to a final, painful finish, there have been some major (and some less so) changes afoot in the global world of cannabis regulation. These developments have also undoubtedly been influenced by recent events, such as the recent elections in the United States, state votes for adult use reform in the U.S. and the overall global temperature towards reform. And while all are broadly positive, they have not actually accomplished very much altogether.

Here is a brief overview of the same.

The UN Vote On Cannabis
Despite a wide celebration in the cannabis press, along with proclamations of an unprecedented victory by large Canadian companies who are more interested in keeping their stock prices high than anything else, the December 2 vote on cannabis was actually fairly indecisive.

Following the WHO recommendations to reschedule cannabis, the UN voted in favor of the symbolic move. Despite removing cannabinoids from Schedule IV globally, a regulatory label designed for highly addictive, prescription drugs (like Valium), the actual results on the ground for the average company and patient will be inconclusive.

The first issue is that the UN did not remove cannabinoids themselves, or the plant, from Schedule I designation. This essentially means that countries and regions will be on the front lines to create more local, sovereign policies. This is not likely to change for at least the next several years (more likely decade) as the globe comes to terms with not just a reality post-COVID-19, but one which is very much pro-cannabis.

In the meantime, however, the ruling will make it easier for research to be conducted, for patient access (for the long term), and more difficult for insurers to turn down in jurisdictions where the supposed “danger” of cannabis has been used as an excuse to deny coverage. See Germany as a perfect example of the same.

It is also a boon for the CBD business, no matter where it is. Between this decision and the recent victory in Europe about whether CBD is a narcotic or not (see below), this is another nail in the coffin for those who want to use semantic excuses to restrain the obvious global desire for cannabinoids, with or without THC.

The U.S. Vote On The MORE Act

While undoubtedly a “victory” in the overall cannabis debate, the MORE Act actually means less rather than more. It will not become law as the Senate version of the bill is unlikely to even get to the floor of the chamber before the end of the session – which ends at the end of this year.

The House voted 228 to 164 to pass the MORE Act.

That said, the vote is significant in that it is a test of the current trends and views towards big issues within the overall discussion, beginning with decriminalization and a reform of current criminal and social justice issues inherent in the same. The Biden Administration, while plagued with a multitude of issues, beginning with the pandemic and its immediate aftershocks, will not be able to push both off the radar. Given the intersection of minority rights’ issues, the growing legality of the drug and acceptance thereof, as well as the growing non-partisan position on cannabis use of both the medical and adult use kind, and the economy, expect issues like banking to also have a hope of reform in the next several years.

Cannabis may be taking a back seat to COVID, in other words, but as the legalization of the industry is bound up, inextricably, in economic issues now front and center for every economy, it will be in the headlines a great deal. This makes it an unavoidable issue for the majority of the next four years and on a federal level.

Prognosis in other words? It’s a good next federal step that is safe, but far from enough.

The European Commission (EC) Has Finally Seen The Light On CBD

One of the most immediately positive and impactful decisions of the last month was absolutely the EC decision on whether CBD is a narcotic or not.

This combined with the UN rescheduling, will actually be the huge boost the CBD industry has been waiting for here, with one big and still major overhanging caveat – namely whether the plant is a “novel” one or not. It is unlikely as the situation continues to cook, that Cannabis Sativa L, when it hits a court of law, will ever be actually found as such. It has inhabited the region and been used by its residents for thousands of years.

However, beyond this, important regulatory guidance will need to fall somewhere on the matter of processing and extraction. It is in fact in the processing and extraction part of the debate that this discussion about Novel Food actually means something, beyond the political jockeying and hay made so far.

Beyond this of course, the marketing of CBD now allowed by this decision, will absolutely move the topic of cannabinoids front and center in the overall public sphere. That linked with sovereign experiments on adult use markets of the THC kind (see Holland, Luxembourg and Denmark as well as Portugal and Spain right after that), is far from a null sum game.

Legal Challenges Of Note

Against this changing regulatory schemata, court cases and legal decisions remain very important as they also add flavor to how regulations are interpreted and followed. The most important court case in Europe right now is the one now waiting to be decided in the Court of Human Rights at Strasbourg regarding the human rights implications of accessing the plant.

Beyond that, in Germany, recent case law at a regional social benefits court (LSG) has begun to establish that the cannabis discussion is ultimately between doctors and their patients. While this still does not solve the problem of doctor reluctance to prescribe the drug, barriers are indeed coming down thanks to legal challenges.

Bottom line, the industry has been handed a nice whiff of confidence, but there is a still high and thorny bramble remaining to get through – and it will not happen overnight, or indeed even over the next several years.

October 22, 2020

A Survey of State CBD & Hemp Regulation Since The 2018 Farm Bill

By Brett Schuman, Jennifer Fisher, Brendan Radke, Gina Faldetta

1 Comment

Since the December 20, 2018 enactment of the Agricultural Improvement Act of 2018, better known as the Farm Bill, we have seen a number of new state laws addressing both the legality of hemp and products derived therefrom, most noticeably cannabidiol, better known as CBD. This piece provides a brief overview of some of the more interesting state laws concerning hemp and CBD, as well as recent developments.

Legality of Hemp

Since the passage of the Farm Bill, the vast majority of states have legalized the cultivation and sale of hemp and hemp products. However, certain states maintain laws barring some or even most forms of hemp.

The most stringent of those states is Idaho, where hemp remains illegal. In March 2020, Senate Bill 1345 – legislation that would have allowed for the production and processing of industrial hemp – died in the House State Affairs Committee, due to concerns that legalizing hemp would be the first step toward legalizing “marijuana”; that the bill contained too much regulation and that it was otherwise unworkable. As a result, Idaho is currently the only state without a legal hemp industry. Hemp with any THC, even at or below the 0.3 percent threshold under the Farm Bill, is considered equivalent to “marijuana” in Idaho and is illegal (see below for a discussion of CBD in Idaho).

Indiana, Iowa, Louisiana, and Texas have enacted bans on smokable hemp. Indiana law prohibits hemp products “in a form that allows THC to be introduced into the human body by inhalation of smoke.” Iowa has amended its Hemp Act to ban products introduced to the body “by any method of inhalation.” Louisiana prohibits “any part of hemp for inhalation” except hemp rolling papers, and Texas law prohibits “consumable hemp products for smoking.”

Some of these bans have been challenged in court. In Indiana, a group of hemp sellers requested an injunction against the smokable hemp ban in federal court, on the grounds that the federal Farm Bill likely preempted the Indiana law. In September of 2019, the district court issued the requested injunction, but the U.S. Court of Appeals for the Seventh Circuit overturned that decision in July 2020, stating that the order “swept too broadly.” The Seventh Circuit noted that the 2018 Farm Bill “expressly provides that the states retain the authority to regulate the production of hemp” and remanded the case for further proceedings.

Similarly, in Texas, hemp producers have sued in state court over the smokable hemp ban, questioning its constitutionality and arguing that it would result in a loss of jobs and tax revenue for the state. According to those producers, smokable hemp comprises up to 50 percent of revenue from hemp products. On September 17, 2020, Travis County Judge Lora Livingston issued a temporary injunction blocking enforcement of the law until trial, which currently is set to commence on February 1, 2021. Judge Livingston had previously issued a temporary restraining order to that same effect.

State Laws Regulating CBD

State laws and regulation on hemp-derived CBD are varied, and the legality of a CBD product often comes down to its form and marketing.

As an initial matter, it must be noted that notwithstanding the Farm Bill the FDA currently prohibits hemp-derived CBD from being be sold as dietary supplements, and food (including animal food or feed) to which CBD has been added cannot be introduced into interstate commerce. As discussed below, a substantial minority of states, including California, follow the FDA’s current position on the permissibility of putting hemp-derived CBD in food or dietary supplements.

Certain states include strict limitations on CBD, none more so than (once again) Idaho. Lacking any legal hemp industry, Idaho restricts CBD products to those having no THC whatsoever, rejecting the generally accepted threshold of not more than 0.3 percent THC. Idaho law also requires that hemp CBD be derived only from “(a) mature stalks of the plant, (b) fiber produced from the stalks, (c) oil or cake made from the seeds or the achene of such plant, (d) any other compound, manufacture, salt, derivative, mixture, or preparation of the mature stalks, or (e) the sterilized seed of such plant which is incapable of germination.”

Kansas similarly prohibits CBD with any amount of THC, though the law is murkier than Idaho’s. While Senate Bill 282 allowed possession and retail sale of CBD effective May 24, 2018 by removing CBD oil from the definition of “marijuana,” this was broadly interpreted to apply to THC-free CBD only. Later legislation, Senate Substitute for HC 2167, effective July 2019, allowed the farming of hemp with THC levels aligned with the Farm Bill definition (i.e., 0.3 percent THC or lower), but expressly prohibited the use of industrial hemp in: cigars, cigarettes, chew, dip, or other smokeless forms of consumption; teas; liquids for use in vaporizing devices; or “[a] ny other hemp product intended for human or animal consumption containing any ingredient derived from industrial hemp that is prohibited pursuant to the Kansas Food, Drug and Cosmetic Act or the Kansas Commercial Feeding Stuffs Act,” though this final section provides that “[t] his does not otherwise prohibit the use of any such ingredient, including cannabidiol oil, in hemp products,” the law’s only reference to CBD. The Kansas Bureau of Investigation has reportedly made statements indicating that CBD with any level of THC remains illegal.

Mississippi only recently legalized the cultivation of hemp via Senate Bill 2725, the Mississippi Help Cultivation Act, which was signed into law on June 29, 2020. House Bill 1547, passed on April 16, 2019, imposed content requirements upon CBD products within Mississippi: to be legal in Mississippi, a CBD product must contain “a minimum ratio of twenty-to-one cannabidiol to tetrahydrocannabinol (20:1 cannabidiol:tetrahydrocannabinol), and diluted so as to contain at least fifty (50) milligrams of cannabidiol per milliliter, with not more than two and one-half (2.5) milligrams of tetrahydrocannabinol per milliliter.” Moreover, CBD products produced in Mississippi must be tested at the University of Mississippi’s lab. However, subject to these restrictions, Mississippi allows the sale of CBD products, including edibles, contrary to the restrictions of many of states considered friendlier to hemp.

Perhaps more surprising is Hawaii, which restricts the sale and distribution of CBD, aligning with the FDA’s guidance. In Hawaii it is illegal to add CBD to food, beverages, as well as to sell it as a dietary supplement or market it by asserting health claims. It is also illegal to add CBD to cosmetics, an uncommon restriction across the many states with CBD-specific laws and regulations. Unlike Idaho and Mississippi, which have no medical marijuana programs, Hawaii has long legalized marijuana for medical purposes and in January 2020 decriminalized recreational possession. Hawaii very recently enacted legislation allowing the production and sale of cannabis-infused consumable and topical products by medical cannabis licensees effective January 1, 2021, but this legislation did not address CBD. Given the foregoing, Hawaii’s restrictions on CBD stand out.

The structure of cannabidiol (CBD), one of 400 active compounds found in cannabis.

Beyond broad CBD restrictions, many more states prohibit the use of CBD within food, beverages, or as dietary supplements. For instance, twenty states – including California, Georgia, Illinois, Massachusetts, Michigan, New Jersey, New York, and Washington – prohibit the sale of CBD in food or beverage. In California, a bill to overhaul California’s hemp laws, Assembly Bill 2028, failed when the legislative session concluded on August 31, 2020 without a vote. AB 2028 would have allowed CBD in food, beverages, and dietary supplements (though, interestingly, it would have banned smokable hemp). As a result, California remains a relatively restrictive state when it comes to hemp-derived CBD, notwithstanding the legality of recreational marijuana.

New York allows the manufacture and sale of CBD, but requires CBD products to be labeled as “dietary supplements.” This mandate conflicts directly with the FDA’s position that CBD products are excluded from the definition of a dietary supplement. Further, despite the state’s categorization of CBD products as dietary supplements, New York prohibits the addition of CBD to food and beverages. These regulations have resulted in a confusing landscape for retailers and manufacturers in the Empire State.

Several states also have labeling requirements specific to CBD products. Batch numbers and ingredients are ubiquitous, but an increasingly common requirement is the inclusion of a scannable code that links to specific information about the product. States imposing this requirement include Florida, Indiana, Texas, and Utah. Indiana is viewed as having one of the more comprehensive labeling requirements for CBD products – or, depending upon your perspective, the most onerous.

September 15, 2020

Biros' Blog

Judge Dismisses Claims in Vaping Illness Lawsuit

By Aaron G. Biros

3 Comments

In September of 2019, Charles Wilcoxen fell seriously ill after vaping cannabis oil from a cartridge. Just days after he began experiencing symptoms he was hospitalized and later diagnosed with lipoid pneumonia, the mysterious lung illness now known as EVALI associated with the 2019 vape crisis.

Wilcoxen spent three days in the hospital and ever since he was diagnosed, he has been unable to exercise, return to work full time or even play with his daughter. Attorneys for Herrmann Law Group representing Wilcoxen filed a product liability lawsuit, Wilcoxen v. Canna Brand Solutions, LLC, et al., in Washington State Court, naming six cannabis companies as defendants: Canna Brand Solutions, Conscious Cannabis, Rainbow’s Aloft, Leafwerx, MFused and Janes Garden.

This image came from the complaint filed, alleging that Mr. Wilcoxen believes this was a CCELL product.

This case was allegedly the first lawsuit in the wake of the 2019 vape crisis. The Vanderbilt University Law School Blog has a very comprehensive post on this case that has the original complaint and a lot of information on the lawsuit.

Canna Brand Solutions, the primary defendant named in the complaint, is a packaging supplier and distributor for CCELL vaping products (heating elements, pens and batteries) in the state of Washington. The complaint alleges that Wilcoxen believes he used a CCELL vape. CCELL is a Chinese company, which makes it notoriously difficult to pursue legal action against them, hence why Canna Brand Solutions was listed as a defendant instead.

On August 31, 2020, Judge Michael Schwartz dismissed all claims against Canna Brand Solutions. “All claims asserted by Plaintiff against Canna Brand in the above-mentioned matter shall be voluntarily dismissed without prejudice and without costs or fees to any of the parties to this litigation,” Judge Schwartz says in the dismissal. Judge Schwartz dismissed the case without prejudice, meaning it could be brought to the court again should the plaintiff’s attorneys decide to do so.

With the allegations against Canna Brand Solutions focusing on CCELL products, it seems that the case was dismissed largely due to a lack of evidence connecting exactly which product resulted in the illness, as well as the lack of culpability for a distributor of products they did not manufacture.

These are the vape cartridges that Mr. Wilcoxen purchased

Daniel Allen, founder and president of Canna Brands Solutions, claims that the product mentioned in the complaint did not come from his company. “We stand by our high quality and customizable CCELL vaporization products,” says Allen. “We feel vindicated in this case by the judge’s decision, which shows the claims against our company and products were completely unfounded from the beginning.”

He also added that the quality and safety of the products they distribute is their highest priority. “The product in question involved in this case did not come from Canna Brand Solutions,” says Allen.

Wilcoxen’s illness and subsequent long-term lung injury is extremely unfortunate. Thousands of people have been hospitalized and 68 deaths have been confirmed by the CDC. The CDC is still calling the illness EVALI (e-cigarette, or vaping, product use-associated lung injury). According to the CDC, there is no real known cause of EVALI, but they have found that vitamin E acetate is “strongly linked” to the outbreak. Knowing that, it is entirely possible that Mr. Wilcoxen’s illness was a result of one of the cannabis products he consumed, just most likely not anything that came from Canna Brand Solutions. A closer look at the contents with an independent lab test of the THC oil he consumed could shed some more light on what exactly caused the illness.

I would venture to guess that one of the products he consumed did have vitamin E acetate. Because the case was dismissed without prejudice, it could be brought to the court again if, say, Mr. Wilcoxen’s attorneys were to obtain more evidence, such as an independent lab report showing vitamin E acetate in the contents of one of the products he consumed. If Mr. Wilcoxen’s attorneys can figure out which product actually contained vitamin E acetate, perhaps the lawsuit could get a second shot and Mr. Wilcoxen could have a greater chance at getting some long-overdue and much-deserved restitution.

August 25, 2020

Consumer Class Actions Against CBD Companies Are Hitting a Snag

By Seth A. Goldberg, Justin M. L. Stern

No Comments

Over the past year, more and more consumer class actions have been filed against manufacturers and distributors of CBD-infused products. These actions typically assert claims based on how the product is marketed, such as whether it (i) contained the advertised amount of CBD, (ii) contained more THC than it should have or (iii) has the ability to provide the therapeutic benefits touted. The marketing of these products is subject to regulation by FDA, which has yet to issue pertinent regulations that have been expected since passage of the 2018 Farm Bill legalizing hemp and CBD products derived therefrom. Thus, in recent months, a number of federal courts have stopped these class actions in their tracks pending further guidance from FDA as to how CBD-infused products should be regulated. This growing body of precedent should be welcome news for the CBD supply chain, as it may provide a disincentive to the plaintiffs’ bar to expend their resources on similar actions until the regulatory framework is clear.

The first case that was put on hold until the “FDA completes its rulemaking regarding the marketing, including labeling, of hemp-derived ingestible products” was Snyder v. Green Roads of Florida, a case about the content of CBD in Green Roads’ products pending in the U.S. District Court for the Southern District of Florida. Then, in May, a judge in the U.S. District Court for the Central District of California took the same approach, deciding to stay the case of Colette v. CV Sciences, Inc., also on account of the lack of FDA regulations. Less than one month later, a judge in the U.S. District Court for the Eastern District of California, relying on the rulings in Snyder and Colette, stayed Glass v. Global Widget, LLC, also under the primary jurisdiction—a doctrine implicated where the claims involve a federal agency’s expertise concerning a regulated product.

On August 11, 2020, two federal judges became the most recent to stay putative class actions involving the sale of CBD products under the primary jurisdiction doctrine: Pfister v. Charlotte’s Web Holdings, Inc., in the U.S. District Court for the Northern District of Illinois, and Ahumada v. Global Widget LLC, in the U.S. District Court for the District of Massachusetts. Both were stayed on account of a lack of regulatory direction from FDA.

A trend appears to be developing, but not all courts faced with the option to stay the proceedings pursuant to the primary jurisdiction doctrine have chosen to put their respective cases on hold. In March, the judge overseeing Potter v. Diamond CBD (pending in the U.S. District Court for the Southern District of Florida) declined to stay the proceedings despite the absence of FDA regulations concerning ingestible CBD products. Despite the defendant’s objection, the court declined to stay the proceedings, finding that to the extent FDA regulations were forthcoming, they would be unlikely to change the food labeling requirements which were at issue in that case.

The stays of federal court cases involving CBD products highlight the need for FDA to issue regulations that cover the marketing of them. They also may provide the CBD product supply chain with a break in the number of consumer class actions filed until such regulations are issued.