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Current Trends in Banking for Cannabis-Related Businesses

By Paula Durham, CFE, CCCE
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Cannabis is still federally illegal and is included on Schedule 1 of the Controlled Substances Act (CSA), along with such other substances as heroin, fentanyl and methamphetamines.1 It is a federal crime to grow, possess or sell cannabis.

Despite being federally illegal, 36 U.S. states and the District of Columbia have legalized the sale and use of cannabis for medical and/or adult use purposes,2 and both direct and indirect cannabis-related businesses (CRBs) are growing at a rapid rate. Revenue from medical and adult use cannabis sales in the US in 2019 is estimated to have reached $10.6B-$13B and is on track to reach nearly $37B in 2024.3

Because the sale of cannabis is federally illegal, financial institutions face a dilemma when deciding to provide services to CRBs. Should they take a significant legal risk or stay out of the market and miss out on a significant revenue opportunity? So far, the vast majority of financial institutions have been unwilling to take the risk, resulting in a dearth of options for CRB’s. Until recently, cannabis business operators had few options for financial services, but times are changing.

This piece will discuss current trends in banking for cannabis-related businesses. We will cover differences in legality at state and federal levels, complexities in dealing in cash versus digital currencies, Congressional actions impacting banking and CRBs and how banking is changing. The explosion of state legalization of cannabis over the past several years has had a strong ripple effect across the US economy, touching many industries both directly and indirectly. Understanding the implications of doing business with a CRB is both challenging and necessary.

Feds Versus States

Money laundering is the process used to conceal the existence, illegal source or illegal application of funds.4 In 1986 Congress enacted the Money Laundering Control Act (MLCA), which makes it a federal crime to engage in certain financial and monetary transactions with the proceeds of “specified unlawful activity.”5 Therefore, CRB transactions are technically illegal transactions under the MLCA.

Financial institutions therefore face a risk of violating the MLCA if they choose to do business with CRBs, even in states where cannabis operations are permitted. In addition, financial institutions could also face criminal liability under the Bank Secrecy Act (BSA) for failing to identify or report financial transactions that involve the proceeds of cannabis businesses operating legally under state law.6

Federal authorities continued to aggressively enforce federal cannabis laws

In short, because cannabis is illegal at the federal level, processing funds derived from CRBs could be considered aiding and abetting criminal activity or money laundering. States, however, began legalizing cannabis in 1996, and by 2009, thirteen states had laws allowing cannabis possession and use.7 Despite this legislation, federal authorities continued to aggressively enforce federal cannabis laws.8 That changed under the Obama administration when, shortly after being elected, President Obama stated that his administration would not target legal CRB’s who were abiding by state laws.[9] In an attempt to provide clarity in this murky environment, beginning in 2009, the Department of Justice (DOJ) issued three memos designed to guide federal prosecutors in this area. However, none of the DOJ memos issued from 2009 through 2013 addressed potential financial crime related to the legal sale or distribution of cannabis in states allowing the use of medicinal or recreational cannabis.

To assist financial institutions in navigating potential financial crime implications of banking CRBs, the Financial Crimes Enforcement Network (FinCen) issued guidance in 2014 that clarified how financial institutions could conduct business with CRBs and maintain compliance with their Bank Secrecy Act requirements (2014 Guidance).9 According to the 2014 Guidance, financial institutions may choose to interact with CRBs based on factors specific to each institution, including the institution’s business objectives, the evaluated risks associated with offering such services, and its ability to manage those risks effectively.

The 2014 Guidance requires those 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.9 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.

Although the 2014 Guidance does outline a path for financial institutions to engage with CRBs, it does not change federal law and, therefore, does not eliminate the legal risk to financial institutions.10 By its very nature, the 2014 Guidance was a temporary fix, subject to changing views of different administrations, evidenced by the fact that all three of the DOJ guidance documents noted above were rescinded by then Attorney General Jeff Sessions on January 4, 2018.12 The DOJ enforcement posture could change once again in a Biden administration. Biden is on record as favoring decriminalization, and Attorney General candidate Merrick Garland has stated that if confirmed he will deprioritize enforcement of low-level cannabis crimes. Garland also believes using limited government resources to pursue prosecution of cannabis crimes states where cannabis is legal does not make sense.12

Because of the uncertainty and high risk, most banks remain unwilling to serve CRBs. Those that do serve CRBs charge exorbitant fees (fees of $750-$1,000 or more per account per month are not uncommon), pricing many smaller operators out of the financial services market.

Cash is King – Or Is It?

Cannabis operators have discovered the old adage “cash is king” is not necessarily true when it comes to the cannabis space. Bank-less CRBs are forced to utilize cash to pay business expenses, which can be particularly difficult. Utility companies, payroll companies, and taxing authorities are just some of the providers that are difficult, if not impossible, to pay in cash. For example, cannabis operators have been turned away from IRS offices when attempting to pay large federal tax obligations in cash. Likewise, cannabis operators have been unable to utilize payroll processing companies to administer payroll and benefits for their businesses because the processors won’t take cash. CRBs can’t use Amazon or other online retailers because online providers cannot accept cash.

Because dealing in cash is so difficult, CRB operators look for workarounds such as using personal credit/debit cards to purchase business equipment and supplies. This doesn’t eliminate the cash problem, however, because the credit card holder will likely have to accept cash as reimbursement. Such transactions could be considered an attempt to hide the source of the cash, which is, by definition, money laundering.

CRBs often have large sums of money onsite

Some bank-less CRBs try to skirt the system by obtaining bank accounts in the name of management companies or other entities one step removed from the actual business. While operators often choose this route in an effort to streamline business and operate out of the shadows, it again runs afoul of banking laws. Transferring cannabis related financial transactions to another entity is actually the very definition of money laundering – which, as noted above, is defined as the process used to conceal the existence or source of “illegal” funds.

In addition to the difficulties in making payments or purchasing business supplies, operating in a cash-heavy environment poses significant safety risks for cannabis operators. CRBs often have large sums of money onsite and transport large sums of cash when purchasing product or paying bills, making them a target for robbery. In 2017, there was a spate of dispensary robberies across the Phoenix Metro area, including one at Bloom Dispensary that took place during operating hours.13

Managing all that cash increases the cost of doing business as well, in the form of increased labor, insurance, and security costs. Cash must be counted and double counted, which can be time consuming for staff, not to mention the time it takes to deliver physical cash payments to hither and yon. Ironically, lack of banking significantly decreases transparency and clouds the waters of compliance, as operating strictly in cash makes it easier to manipulate reported financial results.

Potential Congressional Solutions

In recent years Congress has undertaken several efforts to pass legislation designed to address the state/federal divide on cannabis, which would likely clear the way for financial institutions to provide services to CRBs, including:

  • R. 1595 – Secure and Fair Enforcement Banking Act of 2019 (“SAFE Act”);
  • 1028 & H.R. 2093 – Strengthening the Tenth Amendment Through Entrusting States Act (STATES Act); and
  • 2227 – Marijuana Opportunity Reinvestment and Expungement Act of 2019 (MORE Act).

The climate in Washington DC, however, did not allow any of these initiatives to pass both houses of congress. Had any been sent to the White House, President Trump was unlikely to sign them into law.

The cannabis industry has new reason to believe reform is on the horizon with shift in political leadership in the White House and Senate. Newly anointed Senate Majority Leader Chuck Schumer recently committed to making federal cannabis reform a priority, and President Biden appears committed to decriminalization, reviving the hope of passage of one of these pieces of legislation.

The Changing Banking Landscape

Even though there is little in the way of formal protections for financial institutions, and with the timeline for a legislative fix unknown, an increasing number of banks are working with cannabis operators.

According to FinCen statistics, there were approximately 695 financial institutions actively involved with CRBs as of June 30, 2020. It is important to note that these statistics are based on SAR filings, which banks are required to file when an account or transaction is suspected of being affiliated with a cannabis business. However, some of these SARs may have been generated on genuine suspicious activity rather than on a transaction with a known cannabis customer.

Number of Depository Institutions Actively Banking
Cannabis-Related Businesses in the United States
(Reported in SARS)14

There are arguably more banking institutions offering services to CRBs than ever before. The challenges for CRBs are (1) finding an institution that is willing to offer services; (2) building/maintaining a compliance regime that will be acceptable to that institution; and (3) cost, given the high fees associated with these types of accounts. 

How CRBs Get Accepted by Banks

The gap between CRBs’ need for banking and the financial services providers’ sparse and expensive offerings to the sector has created an opportunity for third-party firms to intervene and provide a compliance structure that will satisfy the needs of the financial institutions, making it easier for the CRB to find a bank.

These third-party firms perform extensive BSA-compliant due diligence on applicants to ensure potential customers are following FinCen guidance required to receive banking services. After the completion of due diligence, they connect the CRBs with financial institutions that are willing to do business with CRBs and provide checking/savings accounts, check writing capability, and merchant processor accounts. These firms often provide additional services such as armored car and cash vaulting services. Some of these firms also offer vendor screening, pre-approving vendors before any payments can be made.

One such firm, Safe Harbor Private Banking, started as a project implemented by the CEO of Partners Credit Union in Denver, Colorado, who set out to design a cannabis banking program that would allow Partners to do business with Colorado CRBs.15 The program was successful and has since expanded into other states who have legalized cannabis. Other operators include Dama Financial and NaturePay.

While these services offer hope for many CRBs, the downside is cost. These services perform the operations necessary to find, open, and maintain a compliant bank account; however, the costs of compliance are still high, pricing some small operators out of the market.

Is Digital Currency an Answer?

 Digital currency is also making its way into the cannabis world. Digital currency, or cryptocurrency, is a medium of exchange that utilizes a decentralized ledger to record transactions, otherwise known as a blockchain. One of the largest benefits of blockchain is that it is a secure, incorruptible digital ledger used for, among other things, financial transactions.16 Blockchain technology offers CRBs a transparent and immutable audit trail for business and financial transactions. Several cannabis-specific cryptocurrencies have sprung up in the past several years, including PotCoin, CannabisCoin, and DopeCoin, to name a few.

In July 2019, Arizona approved cryptocurrency startup ALTA to offer services to the state’s medical cannabis operators.17 ALTA describes itself as a “digital payment club where cash-intensive businesses pay each other using digital tokens instead of cash.”18 ALTA members purchase digital tokens that are used to pay other members using a proprietary blockchain based system. The tokens are redeemable for US dollars at a stable rate of 1:1, and CRBs do not need a bank account to participate in the ALTA program.

ALTA proposes to pick up members’ cash and exchanges it for tokens, which are then used to pay other members for goods and services. Tokens may be redeemed for cash at any time.18 The company has been approved by the Arizona State Attorney General, and one of the first members they hope to enlist is the Arizona Department of Revenue (ADOR). Enlisting ADOR into the program would allow dispensary members to pay state taxes digitally rather than hauling large amounts of cash to ADOR offices.

Similarly, Nevada recently contracted with Multichain Ventures to supply a digital currency solution to the Nevada cannabis industry. Nevada Assembly Bill 466 requires the state create a pilot program to design a “closed loop” system like Venmo in an effort to reduce cash transactions in the cannabis sector. Like ALTA, Nevada’s proposed system will convert cash to tokens which can then be transacted between system participants.19

While both proposals are promising for Arizona and Nevada CRBs, the timeline as to when, or if, these offerings will come online is unknown. Action on cannabis reform at the federal level may render these options moot.

Looking to the Future

Although states are legalizing cannabis in one form or another in growing numbers, the fact that cannabis is still federally illegal poses a significant barrier to accessing the financial services market for CRBs. While most banks are still reluctant to offer services to this rapidly growing industry, there are more banks than ever before willing to participate in the cannabis industry. Recent changes in leadership in Washington DC offer a positive outlook for cannabis reform at the federal level.

As the “green rush” continues to envelop the country, financial services options available to CRBs are slowly growing. Many new options are now available to help CRBs find a bank, develop compliance programs, and manage the cash related problems encountered by most CRBs. However, these solutions may be out of reach for the budget-conscious small operator. Also, there are a number of cryptocurrency solutions designed specifically for CRBs; however, when, or if, these solutions will gain significant traction is still unknown.


References

  1. Controlled Substances Act, 21 U.S.C., Subchapter I, Part B, §812.
  2. “State Marijuana Laws”; National Conference of State Legislatures, February 19, 2021.
  3. “Exclusive: US Retail Marijuana Sales On Pace to Rise 40% in 2020, near $37B by 2024”. Marijuana Business Daily, June 30, 2020.
  4. Kaufman, Irving. “The Cash Connection: Organized Crime, Financial Institutions, and Money Laundering”. Interim Report to the President, October 1984.
  5. S. Code § 1956 – Laundering of Monetary Instruments.
  6. Rowe, Robert. “Compliance and the Cannabis Conundrum.” ABA Banking Journal, September 11, 2016.
  7. “History of Marijuana as a Medicine – 2900 BC to Present”. ProCon.org, December 4, 2020.
  8. Truble, Sarah and Kasai, Nathan. “The Past – and Future – of Federal Marijuana Enforcement”. org, May 12, 2017.
  9. FIN-2014-G001, BSA Expectations Regarding Marijuana-Related Businesses.
  10. Cannabis Banking Coalition Statement.
  11. Sessions, Jefferson B. “Memorandum for All United States Attorneys”. January 4, 2018.
  12. “Attorney General Nominee Garland Signals Friendlier Marijuana Stance”. Marijuana Business Daily, February 22, 2021.
  13. Stern, Ray. “Robbers Hitting Phoenix Medical Marijuana Dispensaries: Is Bank Reform Needed?” The Phoenix New Times, April 11, 2017.
  14. FinCen Marijuana Banking Update, June 30, 2020.
  15. Mandelbaum, Robb. “Where Pot Entrepreneurs Go When the Banks Just Say No.” The New York Times, January 4, 2018.
  16. Rosic, Ameer. “What is Blockchain Technology? A Step-by-Step Guide for Beginners.” com, 2016.
  17. Emem, Mark. “Marijuana Stablecoin Asked to Play in Arizona Fintech Sandbox.” CCN.com, October 25, 2019.
  18. http:\\Whatisalta.com\
  19. Wagner, Michael, CFA. “Multichain Ventures Secures Public Sector Contract with Nevada to Supply Tokenized Financial Ecosystem for the Legal Cannabis Industry”, January 26, 2021.

Senators Introduce The Cannabis Administration And Opportunity Act

By Cannabis Industry Journal Staff
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During a press conference held today, Senate Majority Leader Chuck Schumer, Senate Finance Committee Chair Ron Wyden and Senator Cory Booker introduced the preliminary draft for the Cannabis Administration And Opportunity Act, a bill that would remove cannabis from the list of controlled substances.

“This is the first time in American history that the majority leader of the United States Senate is leading the call to end prohibition of marijuana,” Sen. Booker said toward the end of their remarks. Sen. Wyden stressed the history of the failed war on drugs, the successes of his state’s legalization and the need to include minority-owned small businesses in the new legislation.

Senate Majority Leader Chuck Schumer introducing the bill during today’s press conference

Sen. Schumer emphasized the need for revisions to the bill, bipartisanship and cooperation as they present the preliminary draft to their colleagues. “The waste of human resources because of the historic overcriminalization has been one of the great historical wrongs for the last decades and we are going to change it,” Sen. Schumer said.

While the bill is still in the early stages of its draft, the promising new legislation offers a few provisions that cannabis industry advocates and stakeholders have been hoping to see. Firstly, it would completely remove cannabis from the Controlled Substances Act. It sets up a framework for states to establish their own policies around cannabis, much like the current state of affairs in the industry and also akin to how the federal government treats alcohol.

Speaking to the social equity matters that Sen. Wyden emphasized, the bill would immediately expunge all federal records of non-violent cannabis crimes as well as establish a small business grant program for funding equity applicants, those impacted by the drug war and funding for state-level social equity programs.

Click here to see the draft legislation in its entirety.

photo of outdoor grow operation

The 2020 Global Cannabis Regulatory Roundup

By Marguerite Arnold
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photo of outdoor grow operation

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

The European Court of Human Rights

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.

MORE Act Passes the House – Is Legalization Around the Corner?

By Steve Levine, Alyssa Samuel
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On Friday, December 4, 2020, the US House of Representatives passed the Marijuana Opportunity Reinvestment and Expungement Act of 2019 (the MORE Act), which would effectively legalize cannabis by removing it from the Controlled Substances Act. The bill (H.R. 3884) has several key components:

  • Most importantly, the bill would remove cannabis from the list of controlled substances in the Controlled Substances Act, as well as other federal legislation such as the National Forest System Drug Control Act of 1986. This would effectively end many of the obstacles created by the federal illegality of cannabis such as the lack of access to banking, tax consequences such as 280E, adverse immigration impacts and threats of federal criminal enforcement.

    Rep. Earl Blumenauer (D-OR) donning his cannabis mask as he presides over the Congress
  • Second, not only does the bill preclude future prosecution for cannabis-related crimes, the bill is designed to be retroactive and would provide for the expungement of past non-violent cannabis offenses.
  • The bill creates a prescribed excise tax on cannabis and cannabis products. The funds collected from the taxes would be channeled into opportunity and reinvestment programs.
  • A Community Reinvestment Grant Program would be established aimed at the provision of services for “individuals most adversely impacted by the War on Drugs,” such as job training, education, literacy programs, mentoring, and substance use treatment programs;
  • A Cannabis Opportunity Program would be established providing state funds for small business loans in the cannabis industry targeted at social equity candidates; and
  • An Equitable Licensing Grant Program providing funds for states to implement equitable cannabis licensing programs aimed at minimizing “barriers to cannabis licensing and employment for individuals most adversely impacted by the War on Drugs.”
  • The bill would require all cannabis producers to obtain a federal permit. Cannabis businesses would need to be licensed at the state, local, and federal levels to operate.

This MORE Act is a substantial step in cannabis legislation. Reactions to the proposed legislation have been mixed. While the bill does include some measures aimed at social equity, critics of the bill claim it does not go far enough. Similarly, while the bill includes a federal permitting provision, this would be the beginning of a nascent federal regulatory scheme.

What does this mean for your business? 

While this bill passed in the US House of Representatives, it would still need to pass in the U.S. Senate this term, which by most accounts does not seem likely. However, the passage of this bill signifies the progress that has been made and provides insight on what further legislation may look like.

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How to Vote for Cannabis Research on November 3rd

By Dr. Jordan Zager
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It was 1996. I was four years old. California Proposition 215 passed and for the first time, legal medical cannabis became available. I don’t remember it honestly, but that moment triggered a reckoning of outdated and ineffective efforts to control cannabis, which continues on November 3rd.

The moment in 1996 created for me and my generation of millennials a new, decriminalized lens for which to view cannabis and its potential. In my lifetime, from first experimenting with cannabis after high school and then earning my PhD in plant biochemistry, advancing cannabis research, to starting an agtech company dedicated to the genetic improvement of cannabis, we continue this march toward legalization. But another march hasn’t started yet.

The cannabis we consume today is still largely the same (albeit more potent today) as the cannabis that was legalized in 1996. There’s been little advancement in our scientific understanding of the plant. This can and should change. I believe the future and legitimacy of the cannabis crop in the medical field and in farmers’ fields is on the ballot this November.

Five states have cannabis on the ballot for November 3rd

In 33 states, medical cannabis is currently legal and in eleven of those, including my home states of Nevada and Washington, legalized adult-use recreational cannabis is generating millions in tax revenue every month. But compared to every other commercial crop, cannabis is still decades behind.

We are seeing a glacial cadence with cannabis research. As voters in five more states consider this November whether to legalize cannabis, that same tipping point we reached in 1996 comes closer to being triggered for cannabis research.

Here’s what cannabis scientists, like me, face as we work to apply real scientific methods to the long-neglected crop: I published one of the most cited papers on cannabis research last year, titled, Gene Networks Underlying Cannabinoid and Terpenoid Accumulation in Cannabis. But, as per university policy, we were unable to touch the plant during any of our research. We could not study the physical cannabis plant, extracts or any other substantive physical properties from the plant on campus or as a representative of the university. Instead we studied cannabis DNA processed through a third-party. Funding for the research came from private donors who were required to be unassociated with the cannabis industry.

While we were conducting our heavily restricted, bootstrapped cannabis research, the university lab in the next building over was experimenting with less restrictions on mice using other drugs: cocaine, opioids and amphetamines. (Quick note, marijuana is listed as more dangerous than cocaine, which is a Schedule II drug.)

I get it. Due to the federal prohibition on cannabis as a heavily regulated Schedule I drug, universities cannot fund research without the risk of losing all of their federal funding. While the USDA does not support research and SBIR grants are all but impossible, one government agency does allow research, from cannabis grown only in Mississippi. It’s the Drug Enforcement Agency (DEA) and any research conducted using its crop is as ineffective as you’re imagining. Relevant research is likely impossible using the crop which dates back to a 1970’s strain with a potency that’s about 30 percent of today’s commercial cannabis offerings.

To change this anti-research climate, do what those in California did with Prop 215 in 1996. Vote.

Dr. Jordan Zager, author and CEO of Dewey Scientific

Vote for legalization of cannabis if you’re in those five states where legalization is on the ballot; that’s Arizona, New Jersey, Montana, South Dakota and Mississippi. The more states that align with cannabis legalization, the stronger the case becomes for the federal government to reschedule the drug from a Schedule I controlled substance. Currently cannabis is listed as a Schedule I alongside heroin. The DEA claims cannabis has no currently accepted medical use and a high potential for abuse. Both are not true, just listen to the scientists.

Those outside of the five states putting cannabis on the ballot can still play a role in creating a Congress that is more receptive to cannabis reform. This Congress is the oldest, one of the most conservative and least effective in our country’s history. Younger, more progressive representation will increase our odds of advancing cannabis research.

Cannabis holds far too much possibility for us to allow it to be an unstudied “ditch weed.” THC and CBD are just two of nearly 500 compounds found in cannabis which, when scientifically scrutinized will harvest – I believe – vast medicinal and commercial benefits and the tax windfalls that accompany both. But first you have to vote.

If cannabis and your representatives are not on the ballot, do something millennials have built somewhat of a reputation for failing to do; pick up a phone and call your current representative. Tell them cannabis deserves scientific attention and investment. There’s too much potential in the cannabis plant to wait any longer.

How GW Pharma Won CBD

By Cathleen Rocco
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As of this writing, the United States Food and Drug Administration (FDA) has approved GW Pharma’s CBD drug Epidiolex for treating profound refractory pediatric epilepsy syndromes (Dravet syndrome and Lennox Gastaut syndrome) as well as for treating seizures associated with tuberous sclerosis complex (TSC) in patients one year of age or older. The product is a very simple, orally-administered formulation comprised of 100mg/ml cannabidiol (CBD), dehydrated alcohol, sesame seed oil, strawberry flavor and sucralose – basically, an alcohol-based solution with sesame seed oil to help solubilize the CBD oil, flavoring and sweetener.

GW logo-2On April 6th, 2020 GW Pharma performed a regulatory miracle when they succeeded in convincing the Drug Enforcement Administration (DEA) to deschedule Epidiolex (i.e., remove it from the Schedule 1 and Schedule 5 lists of substances that the agency regulates due to concerns regarding safety, potential for abuse or both) for all indications – including indications for which it has not yet been approved by the FDA.1 The benefit to GW of having their product descheduled is incalculable. This status change removed potential barriers to insurance reimbursement and made the need to set up and administer an expensive REMS2 drug safety program less likely. In part because of this regulatory coup d’état, the drug recently posted yearly earnings of nearly $300 million.

It is important to note that the DEA descheduled the Epidiolex formulation and not cannabis-derived CBD itself. Thus, GW Pharma is now in the enviable position of being the only company that can legally sell cannabis-derived CBD. More importantly, because the DEA descheduled the formulation and not the active ingredient, other companies who wish to market cannabis-derived CBD pharmaceutical formulations will have to repeat whatever it is that GW did to get Epidiolex descheduled.3 The DEA effectively gave the company a huge head start with respect to competitors who are developing other cannabis-derived CBD formulations that would compete with Epidiolex. That advantage will remain in place unless and until cannabis-derived CBD itself is descheduled or cannabis is legalized at the federal level.

GW Pharma’s CBD drug Epidiolex, which is FDA-approved to treat profound refractory pediatric epilepsy syndromes

GW Pharma’s attorneys demonstrated considerable virtuosity in devising this approach. However, there is another aspect of the GW Pharma story – one that could have profound implications for the exploding CBD consumer packaged goods (CPG) industry. The Federal Food, Drug, and Cosmetics Act4 (FFDCA) prohibits the introduction into interstate commerce of any food to which has been added an approved drug or a drug for which substantial clinical investigations have been instituted and made public.5 Because CBD was and is still the subject of clinical trials run by GW Pharma and others, even hemp-derived CBD is currently illegal to use as a food additive or dietary supplement under the FDCA

The FDA has recently re-started the public commentary stage of a long process that will hopefully result in the creation of a regulatory pathway for CBD to be used as a food additive – something that would seemingly be a straightforward matter given the copious amounts of safety data being generated from all of GW Pharma’s clinical trials. However, as long as the FDA continues to drag its feet in providing a regulatory pathway for CBD CPG products, CBD, regardless of its source, will remain illegal to use as a food additive or supplement under either the CSA or the FFDCA despite the existence of safety data obtained through the Epidiolex clinical trials. If, as many people in the industry anticipate, the agency decides to begin enforcement action, this could have a hugely negative impact on the industry.

In addition to the potentially disastrous effect that federal law could have on an important new industry, the federal regulatory scheme introduces unnecessary regulatory complexity and cost by imposing two different regulatory schemes depending on the source of the CBD. CBD derived from hemp is chemically identical to CBD derived from cannabis. Despite that identity, the 2018 Farm Bill nonsensically exempts only hemp-derived CBD from the Controlled Substances Act. If a regulatory pathway is created for hemp-derived CBD, but the DEA insists on maintaining cannabis-derived CBD as a schedule 1 substance, then the same molecule will be subject to two different regulatory schemes. This scenario would require tracking and certifying CBD sources and thereby impose regulatory and economic burdens that are entirely unnecessary from a public health point of view.

FDAlogoAn alternative, economically disastrous scenario: given the pharmaceutical industry’s formidable lobbying power, it is entirely possible that the FDA could decide to limit the use of CBD exclusively in prescription drug formulations. This could kill the entire US hemp CBD CPG industry, currently estimated to reach $22 billion by 2022.6

Overall, the current state of affairs is unfair, expensive, uncertain and entirely unworkable over the long term. The CSA must be amended, ideally to deschedule both hemp and cannabis entirely, but at least in the short term, to deschedule CBD and preferably all non-THC cannabinoids regardless of their source. Further, the FDA must provide a regulatory pathway to allow the use of low doses of cannabinoids shown to be safe, either by existing clinical trial data or future testing pursuant to the NDIN submission process.

A 2019 Gallup poll found that 14% of Americans – 1 in 7 – use CBD products.7 The demand is there, the industry is thriving, and adequate safety data exists to justify a regulatory system that allows low-dose over the counter CBD products provided those products are produced using Current Good Manufacturing Practices (CGMPs) for food and dietary supplement manufacturing prescribed by the FDA and that such products undergo regular testing that demonstrates they are safe, unadulterated and accurately labeled. It is time for the industry to collectively fund a New Dietary Ingredient Notification (NDIN) submission that would provide safety data sufficiently compelling to force the FDA to either recognize CBD and other non-THC cannabinoids as being GRAS substances regardless of their source, or in the alternative create a regulatory path for CPG products containing low-doses of CBD and other non-THC cannabinoids.

Editor’s Note: The opinions expressed in this publication are those of its author. They do not purport to reflect the opinions or views of the Cannabis Industry Journal, its editorial staff or its employees.


References

  1. Clincialtrials.gov lists 256 different clinical trials in which Epidiolex has been, is being or will be tested for a wide variety of other indications, including but not limited to opioid use disorder, several types of prostate cancer, alcohol use disorder, musculoskeletal pain, and a host of others.
  2. REMS – risk evaluation and mitigation strategy – are drug safety programs that the FDA requires in cases where mediations pose serious safety concerns with respect to potential abuse and other adverse effects.
  3. Exactly what they did isn’t clear, and won’t be for a long while given the snail’s pace at which FOIA requests are filled.
  4. Title 21 United States Code Chapter 9
  5. Title 21 United States Cod Chapter 9, Sections 331(ll), 342(a)(1) and Section 342(d)(f)(1)
  6. “Exclusive: New Report Predicts CBD Market Will Hit $22 Billion by 2022” Rolling Stone Magazine, September 11, 2018, citing cannabis industry analysis from the Brightfield Group.
  7. Gallup poll on American CBD product usage

The DEA’s Interim Final Rule and its Impact on the Industrial Hemp Industry

By Seth Mailhot, Steve Levine, Emily Lyons, Megan Herr
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On August 20, 2020, the Drug Enforcement Administration (DEA) published an Interim Final Rule on industrial hemp and hemp derivatives (the interim rule), which immediately went into effect, to conform DEA regulations with the Agriculture Improvement Act of 2018 (the 2018 Farm Bill).

The 2018 Farm Bill effectively removed industrial hemp from the definition of “marijuana” in the Controlled Substances Act (CSA). Additionally, tetrahydrocannabinols contained in industrial hemp, such as cannabidiol (commonly known as CBD), were also removed from the purview of the CSA.

The 2018 Farm Bill defines hemp as:

the plant Cannabis Sativa L. and any part of that plant, including the seeds thereof and all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers, whether growing or not, with a delta-9 tetrahydrocannabinol concentration of not more than 0.3 percent on a dry weight basis.

Accordingly, because cannabis and its “derivatives, extracts, [and] cannabinoids” are not considered “marihuana,” so long as their delta-9 tetrahydrocannabinol (THC) concentration is at or below 0.3% on a dry weight basis, the regulation of hemp fell outside the authority of the DEA. However, the DEA’s interim rule attempts to draw a hard line in the sand as to when the plant, and any products derived therefrom, are considered “marihuana,” thereby still subject to the DEA’s purview.

Specifically, the interim rule promulgates the DEA’s position that hemp processors can convert otherwise legal hemp into illegal “marihuana,” thereby bringing it back under the DEA’s authority, if such processing and extraction increases the THC content above the 0.3% THC threshold, even momentarily. Specifically, the interim rule states:

[T]he definition of hemp does not automatically exempt any product derived from a hemp plant, regardless of the Δ9-THC content of the derivative. In order to meet the definition of ‘hemp,’ and thus qualify for the exemption from [S]chedule I, the derivative must not exceed the 0.3% Δ9-THC limit. The definition of ‘marihuana’ continues to state that ‘all parts of the plant Cannabis sativa L.,’ and ‘‘every compound, manufacture, salt, derivative, mixture, or preparation of such plant,’ are [S]chedule I controlled substances unless they meet the definition of ‘hemp’ (by falling below the 0.3% Δ9-THC limit on a dry weight basis) or are from exempt parts of the plant (such as mature stalks or non-germinating seeds) . . . As a result, a cannabis derivative, extract, or product that exceeds the 0.3% Δ9-THC limit is a [S]chedule I controlled substance, even if the plant from which it was derived contained 0.3% or less Δ9-THC on a dry weight basis.

Accordingly, the DEA’s stance creates a substantial risk for processors who will be considered to be in possession of a Schedule I controlled substance during the extraction process if the THC content exceeds the 0.3% THC threshold at any point during processing, an almost inevitable result of the extraction process. Nevertheless, the interim rule states:

the definition of hemp does not automatically exempt any product derived from a hemp plant, regardless of the Δ9-THC content of the derivative. In order to meet the definition of ‘hemp,’ and thus qualify for the exemption from [S]chedule I, the derivative must not exceed the 0.3% Δ9-THC limit.

Although the DEA impliedly recognizes the fact that hemp processing can result in a temporary increase in THC content, it still took the position that, should the THC content exceed 0.3% THC at any point during the extraction process, processors will be considered to be in possession of a Schedule I controlled substance, regardless of whether the finished product complies with federal law.

Just some of the many hemp-derived CBD products on the market today.

Consequently, the interim rule creates significant criminal risk for anyone processing industrial hemp, as the DEA has asserted that the processing of hemp into extracts, derivatives and isolated cannabinoids (which are arguably legal under the 2018 Farm Bill) can result in unintentional violation of federal law, thereby subjecting processors to the risk of significant criminal liability. That said, the interim final rule does not appear to be a shift in DEA policy since the passage of the 2018 Farm Bill in December 2018, nor has DEA issued any warnings to industrial hemp manufacturers or otherwise signaled a change in enforcement policy by issuing the Interim Final Rule.

In addition, the DEA took several other steps in the interim final rule towards the deregulation of hemp products:

  • Adding language stating that the definition of “tetrahydrocannabinols” does not include “any material, compound, mixture, or preparation that falls within the definition of hemp set forth in 7 U.S.C. § 1639o”.
  • Removing from Schedule V a “drug product” in an FDA-approved finished dosage formulation that contains cannabidiol (CBD) and no more than 0.1 percent (w/w) residual tetrahydrocannabinols (e.g. Epidiolex).
  • Removing DEA import and export controls for hemp extract that does not exceed the statutory 0.3% THC limit.
FDAlogo

CBD Industry Caught Between Regulators & Law Enforcement

By Gregory S. Kaufman
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FDAlogo

The consumer-facing CBD industry operates in a regulatory gray zone even as it grows in prominence. Illegal to market as an unapproved drug, dietary supplement or food additive under the Food, Drug & Cosmetic Act, nevertheless, the CBD industry has flourished with ingestible products widely available. With the increased consumer interest in CBD, headwinds in the form of mislabeled or contaminated products and unsubstantiated therapeutic claims, combined with regulatory uncertainty, continue to be a drag on legitimate market participants and consumer perception of CBD products. The regulation of hemp-derived CBD falls under the purview of the Food and Drug Administration (FDA) and its charge to protect the public health. Despite having jurisdiction to regulate CBD products, the FDA has done little to bring regulatory certainty to the CBD marketplace. However, the FDA, with the assistance of the National Institute of Standards and Technology (NIST), recently took important steps that can be described as “getting their ducks in a row” for the eventual regulation of hemp-derived CBD in consumer products. Always looming is the threat of criminal enforcement of the Controlled Substances Act (CSA) by the Department of Justice’s Drug Enforcement Administration (DEA) for plants and products not meeting the definition of hemp.

Prior to July 2020, the FDA’s regulation of the CBD industry was limited to a public hearing, data collection, an update report to Congress on evaluating the use of CBD in consumer products, and issuing warning letters to those marketing products for treatment of serious diseases and conditions. The FDA recognizes that regulatory uncertainty does not benefit the Agency, the industry or consumers and, therefore, is evaluating a potential lawful pathway for the marketing of CBD products. In furtherance of this effort, the FDA took several recent actions, including:

  • Producing a CBD Testing Report to Congress1
  • Providing draft guidance on Quality Considerations for Clinical Research2
  • Sending a CBD Enforcement Policy to the Office of Management and Budget for pre-release review and guidance3

FDAlogoNot to be overlooked, the NIST announced a program to help testing laboratories accurately measure compounds, including delta-9 tetrahydrocannabinol (THC) and CBD, in marijuana, hemp and cannabis products, the goal being to increase accuracy in product labeling and to assist labs in identifying THC concentrations in order to differentiate between legal hemp and federally illegal marijuana. These actions appear to be important and necessary steps towards a still be to determined federal regulatory framework for CBD products. Unfortunately, a seemingly innocent interim final rule issued by the DEA on August 21, 2020 (Interim Final Rule), may prove to be devastating to hemp processors and the CBD industry as a whole.4 While the DEA describes its actions as merely conforming DEA regulations with changes to the CSA resulting from the 2018 Farm Bill, those actions may make it exceedingly difficult for hemp to be processed for cannabinoid extraction without violating the CSA in the process.

  1. FDA Report to Congress “Sampling Study of the Current Cannabidiol Marketplace to Determine the Extent That Products are Mislabeled or Adulterated

On July 8, 2020, the FDA produced a report to the House and Senate Committees on Appropriations detailing the results of a sampling study to determine the extent to which CBD products in the marketplace are mislabeled or adulterated. The study confirmed what the FDA, Congress and the marketplace already knew – that in this regulatory vacuum, there are legitimate concerns about the characteristics of consumer CBD products. These concerns include whether products contain the CBD content as described in the label, whether products contain other cannabinoids (including THC) and whether products were contaminated with heavy metals or pesticides. With these concerns in mind, the FDA tested 147 CBD and hemp products purchased online for the presence of eleven cannabinoids, including determinations of total CBD and total THC, and certain heavy metals. The key tests results included the following:

  • 94% contained CBD
  • 2 products that listed CBD on the label did not contain CBD
  • 18% contained less than 80% of the amount of CBD indicated
  • 45% contained within 20% of the amount listed
  • 37% contained more than 20% of the amount of CBD indicated
  • 49% contained THC or THCA at levels above the lowest concentration that can be detected
  • Heavy metals were virtually nonexistent in the samples
The structure of cannabidiol (CBD), one of 400 active compounds found in cannabis.

Due to the limited sample size, the FDA indicated its intention to conduct a long-term study of randomly selected products across brands, product categories and distribution channels with an emphasis on more commercially popular products. In furtherance of this effort, on August 13, 2020, the FDA published a notice soliciting submissions for a contract to help study CBD by “collecting samples and assessing the quantities of CBD and related cannabinoids, as well as potential associated contaminants such as toxic elements, pesticides, industrial chemicals, processing solvents and microbial contaminants, in foods and cosmetics through surveys of these commodities.”5

Even though this report was not voluntarily produced by the FDA, rather it was required by Congress’ Consolidated Appropriations Act of 2020, it importantly solidified a basis for the need for regulation. With less than half of the products tested falling within the 20% labeling margin of error, this suggests rampant and intentionally inaccurate labeling and/or significant variability in the laboratory testing for cannabinoids.

  1. NIST Program to Help Laboratories Accurately Measure Compounds in Hemp, Marijuana and Cannabis Products

 Proper labeling of cannabinoid content requires reliable and accurate measurement of the compounds found in hemp, marijuana and cannabis products. As part of NIST’s Cannabis Quality Assurance Program, NIST intends to help labs produce consistent measurement results for product testing and to allow forensic labs to distinguish between hemp and marijuana.6 As succinctly stated by a NIST research chemist, “When you walk into a store or dispensary and see a label that says 10% CBD, you want to know that you can trust that number.” Recognizing the lack of standards due to cannabis being a Schedule I drug for decades, NIST intends to produce standardized methods and reference materials the help labs achieve high-quality measurements.

NIST’s efforts to provide labs with the tools needed to accurately measure cannabis compounds will serve as an important building block for future regulation of CBD by the FDA. Achieving nationwide consistency in measurements will make future FDA regulations addressing CBD content in products achievable and meaningful.

  1. FDA Industry Guidance on Quality Considerations for Clinical Research on Cannabis and Cannabis-Derived Compounds

On July 21, the FDA released draft guidance to the industry addressing quality considerations for clinical research of cannabis and cannabis-derived compounds related to the development of drugs. These recommendations are limited to the development of human drugs and do not apply to other FDA-regulated products, including food additives and dietary supplements. However, by indicating that cannabis with .3% or less of THC can be used for clinical research and discussing testing methodologies for cannabis botanical raw material, intermediaries and finished drug products, the FDA is potentially signaling to the consumer-facing CBD industry how the industry should be calculating percentage THC throughout the product formulation process.

While testing of botanical raw material is guided by the USDA Interim Final Rule on Hemp Production,7 the FDA warns that manufacturing processes may generate intermediaries or accumulated by-products that exceed the .3% THC threshold and may be considered by the DEA to be Schedule I controlled substances. This could be the case even if the raw material and finished product do not exceed .3% THC. The FDA’s guidance may eventually become the standard applied to regulated CBD products in a form other than as a drug. However, through its guidance, the FDA is warning the CBD industry that the DEA may also have a significant and potentially destructive role to play in the manufacturing process for CBD products.

  1. FDA Submits CBD Enforcement Policy Guidance to the White House

On July 22, 2020, the FDA submitted to the White House Office of Management and Budget a “Cannabidiol Enforcement Policy – Draft Guidance for Industry” for its review. The contents of the document are not known outside of the Executive Branch and there is no guarantee as to when, or even if, it will be released. Nevertheless, given the FDA’s interest in a legal pathway forward for CBD products, the submission is looked upon as a positive step forward. With this guidance, it is important to remember that the FDA’s primary concern is the safety of the consuming public and it continues to collect data on the effects of ingestible CBD on the human body.

It is doubtful that this guidance will place CBD products in the dietary supplement category given the legal constraints on the FDA and the lack of safety data available to the FDA. The guidance likely does not draw distinctions among products using CBD isolate (as found in Epidiolex), full or broad spectrum hemp extract, despite the FDA’s expressed interest in the differences between these compositions.8 Instead, the FDA is more likely to establish guardrails for CBD ingestible products without authorizing their marketing. These could include encouragement of Good Manufacturing Practices, accuracy in labeling, elimination of heavy metal and pesticide contamination, and more vigorous enforcement against marketing involving the making of disease claims. The FDA is not expected to prescribe dosage standards, but may suggest a maximum daily intake of CBD for individuals along the lines of the U.K.’s Food Standards Agency guideline of a maximum of 70 mg of CBD per day.9

Identifying concerns in the current marketplace; promoting accuracy in testing; highlighting the line between FDA regulation and DEA enforcement; and proposing guidance to the industry all appear to be signs of substantial progress on forging a regulatory path for ingestible CBD products.

  1. The DEA’s Interim Final Rule Addressing Derivatives and Extracts Could Have a Devastating Impact on the Cannabinoid Industry

The seemingly benign Interim Final Rule published by the DEA in August with the stated intent of aligning DEA regulations with the changes to the CSA caused by the 2018 Farm Bill’s definition of hemp could cut the legs out from under the hemp-derived CBD industry.10 Claiming it has “no discretion with respect to these amendments,” the DEA rule states that “a cannabis derivative, extract, or product that exceeds the 0.3% delta-9 THC limit is a schedule I controlled substance, even if the plant from which it was derived contained 0.3% or less delta-9 THC on a dry weight basis.”11 Under this interpretation of the 2018 Farm Bill language and the CSA, it is unclear whether processors of hemp for cannabinoid extraction would be in possession of a controlled substance if, at any time, a derivative or extract contains more than 0.3% delta-9 THC even though the derivative or extract may be in that state temporarily and/or eventually falls below the 0.3% threshold when included in the final product. It would not be unusual for extracts created in the extraction process to exceed 0.3% delta-9 THC in the course of processing cannabinoids from hemp.

The implications of the rule may have a chilling effect on those involved in, or providing services to, hemp processors. It is known, as revealed by the Secretary of the USDA to Congress, that the DEA does not look favorably on the legalization of hemp and development of the hemp industry. The DEA’s position is that the rule merely incorporates amendments to the CSA caused by the 2018 Farm Bill’s definition of hemp into DEA’s regulations. In doing so, the DEA made explicit its interpretation of the Farm Bill’s hemp provisions that it presumably has held since the language became operative. What is not known is whether this changes the DEA’s appetite for enforcing the law under its stated interpretation, which to date it has refrained from doing. Nevertheless, the industry is likely to respond in two ways. First, by submitting comments to the Interim Final Rule, which will be accepted for a 60-day period, beginning on August 21, 2020. Anyone concerned about the implications of this rule should submit comments by the deadline. Second, by the filing of a legal challenge to the rulemaking on grounds that the rule does not correctly reflect Congressional intent in legalizing hemp and, consequently, the rulemaking process violated the Administrative Procedure Act. If both fail to mitigate harm caused to the CBD industry, the industry will have to look to Congress for relief. In the meantime, if the hemp processing industry is disrupted by this rule, cannabis processors holding licenses in legal states may be looked upon to meet the supply needs of the CBD product manufacturers.

The Interim Final Rule also addresses synthetically derived tetrahydrocannabinols, finding them to be Schedule I controlled substances regardless of the delta-9 THC content. This part of the rule could impact the growing market for products containing delta-8 THC. While naturally occurring in hemp in small quantities, delta-8 THC is typically produced by chemically converting CBD, thereby likely making the resulting delta-8 THC to be considered synthetically derived.

The hemp-derived cannabinoid industry continues to suffer from a “one step forward, two steps back” syndrome. The USDA’s highly anticipated Interim Final Rule on hemp production (released Oct. 31, 2019) immediately caused consternation in the CBD industry, and continues to, due to certain restrictive provisions in the rule. Disapproval in the rule is evident by the number of states deciding to operate under their pilot programs for the 2020 growing season, rather than under the conditions of the Interim Final Rule.12 With signs of real progress by the FDA on regulating the CBD products industry, yet another interim final rule could undercut the all-important processing portion of the cannabinoid supply chain by injecting the threat of criminality where there is no intent by processors to violate the law. It is not a stretch to suggest that both the USDA and FDA are being significantly influenced by the DEA. The DEA’s Interim Final Rule is just another troubling example of the legal-illegal dichotomy of cannabis that continues to plague the CBD industry.


References

  1.  U.S. Food & Drug Admin., Report to the U.S. House Committee on Appropriations and the U.S. Senate Committee on Appropriations, Sampling Study of the Current Cannabidiol Marketplace to Determine the Extent That Products are Mislabeled or Adulterated (July 2020).
  2. U.S. Food & Drug Admin., Cannabis and Cannabis-Derived Compounds Quality Considerations for Clinical Research: Guidance for Industry(July 2020).
  3. U.S. Food & Drug Admin., Cannabidiol Enforcement Policy: Draft Guidance for Industry (July 2020).
  4. Implementation of the Agriculture Improvement Act of 2018, 85 FR 51639 (Aug. 21, 2020) (to be codified at 21 C.F.R. §§ 1308, 1312).
  5. U.S. Food & Drug Admin., Collection and Analysis of Products Containing CBD and Cannabinoids, Notice ID RFQ_75F40120R00020 (Aug. 13, 2020).
  6. Nat’l Inst. of Standards and Tech., NIST to Help Labs Achieve Accurate THC, CBD Measurements (July 21, 2020).
  7. Agricultural Improvement Act of 2018, Pub. L. 115-334, title X, 10113 (codified at 7 U.S.C. §§ 1639o-1639s).
  8. U.S. Food & Drug Admin., Report to the U.S. House Committee on Appropriations and the U.S. Senate Committee on Appropriations, Cannabidiol (CBD), p. 14 (March 2020).
  9. U.K. Food Standards Agency, Food Standards Agency Sets Deadline for the CBD Industry and Provides Safety Advice to Consumers (Feb. 2020) at https://www.food.gov.uk/news-alerts/news/food-standards-agency-sets-deadline-for-the-cbd-industry-and-provides-safety-advice-to-consumers.
  10. See supra n. 4.
  11. Id.
  12. U.S. Dept. of Agriculture, Status of State and Tribal Hemp Production Plans for USDA Approval (as of Aug. 26, 2020).

South Africa Reschedules CBD and THC

By Marguerite Arnold
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The South African government has taken a leap into the future (ahead also of the expected World Health Organization (WHO) decision on cannabis this December). Namely, it has begun to regulate hemp (more in line with Europe intriguingly, than the U.S.) and attempted to remove the THC part of the equation from a domestic list of plants and drugs with no medical use.

The notice was signed by South African Minister of Health Zweli Mkhize and published a week after a domestic moratorium on CBD expired. The moratorium permitted the sale of some kinds of CBD products.

This is an intriguing new development, although it will also undoubtedly cause headaches for the burgeoning industry in the region.

On The CBD Front…

South Africa’s new hemp guidelines – namely for the amount of THC allowed in legit hemp crops that are also regulated – are that plants contain no more than 0.2% THC. This makes the guidelines absolutely in line with what is generally developing across the EU. And even more intriguingly, below federal guidelines for most U.S. domestic hemp crops (which are 0.3% at a federal level and only differ in a few state cases where the amount is lower by state law).

However, there is also a unique twist to all of this: The South African government has now created a two-pronged regulatory schemata just for CBD. The default approach to the cannabinoid is that it is in fact medication, scheduled under South African internal and global drug guidelines as a “Schedule 4” drug.

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

The other designation is reserved for CBD packaged in sizes of 600mg or less (and limited by instructions to no more than 20mg a day). This kind of CBD (despite the dubious understanding of cannabinoid science) will henceforth be labelled a “supplement” and on “Schedule 0”.

However, do not be fooled: This is not “descheduling.” This actually means that all CBD has been classified as a medical substance except in packets that are under a certain size, with portion suggestions on the outside of the wrapper or package.

That is hardly scientific. However, what is more burdensome is that any CBD cultivator in South Africa must also be GMP- (or internationally medically) certified (even if bound for the supplement market). By definition, in other words, it will make the cost of production for the supplement (commercial, food and cosmetic) part of the equation as expensive as pharmaceutical production. While from a purist’s point of view, having ultra clean cannabis in any product (at the level of pharmaceutical standards) is a wonderful idea, but this gets ridiculous when it comes to reality, and will ultimately never stand.

This development is also undeniably inconvenient (at minimum) for any who had envisioned outdoor hempires, which most of the cannabis grown in South Africa is. The only people who have the money to build indoor grows, starting with GMP certified greenhouses, are, for the most part, white people, foreigners or those who own property and have access to external, international equity.

The sins of Apartheid, in other words, are being writ large on the entire cannabis industry at present in South Africa. And CBD is contained right in the middle of the mix.

On The THC Front…

There are several interesting aspects to this.

The first is that THC has been removed from the South African “Schedule 7” which is roughly equivalent to the international “Schedule I” that cannabis also resides in until the WHO re- or deschedules the same.

However, this also means that all CBD as well as THC must be produced by those with pharmaceutical-grade facilities – and this of course includes more than just indoor, temperature-controlled greenhouses. It also includes a complex supply chain that is European and Western centric, starting with the requirement to access a rather large amount of capital to construct the same.

Global Re-Alignment Or Stopgap Measure?

This new regulation, in other words, specifically leaves the vast majority of what has already been seeded, or what is most likely to be, in the hands of a few Canadian and other companies who have been moving in this direction for the last several years.

It also implies, intriguingly, that the intra-African cannabis market is low priority at present for those writing the (health) rules. And that also means that eyes are being set more on creating an export market than for treating South African citizens.

It is not an unusual move, rather tragically so far. And almost certainly one that will be challenged, and in several directions, both by events, but also by firms caught up in the mix.

Why? For starters, the South African cannabis market also effectively controls the Lesotho cannabis regulatory scheme (namely all exports from Lesotho, which has seen quite a lot of cannabis investment over the last several years). All such crops must be labelled per South African guidelines if they, literally, can hit a port to be exported.

The vast majority of those grows, even with relatively decent foreign backing, are also outside – and of course as a result ineligible for GMP certification.

Of course given the fact that the UN is likely to clarify both the status of THC and CBD by the end of the year, this current situation in South Africa is also fairly clearly intended to be a stop-gap regulatory measure to last up until at least this time.

Where it may go after that is anyone’s guess. This measure, however, is also clearly being made to protect those who have invested in GMP-grade facilities as opposed to those who have been clearly angling for reform on the CBD front, starting with the beer market. Stay tuned. Interesting developments clearly ahead.

Cannabis Contracting: The Potential Invalidity Defense Created By Federal Prohibition

By Brett Schuman, Barzin Pakandam, Jennifer Fisher, Nicholas Costanza
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The overwhelming majority of Americans now live in a state where cannabis is legal at the state level for at least some purposes.1 However, cannabis (excluding hemp) remains criminal under federal law for all purposes. This conflict between state and federal law presents challenges for participants in the state legal cannabis industry, including enforcing their contractual agreements. This is because a number of federal court rulings have called into question whether contracts involving cannabis are enforceable in federal court.

In this article, we explore how federal courts and state legislatures have addressed the enforceability of contracts relating to cannabis and provide some practical tips for cannabis companies to protect their contractual rights.

The “Illegality Defense” in Federal Courts

“No principle of law is better settled than that a party to an illegal contract cannot come into a court of law and ask to have his illegal objects carried out . . . .” Mann v. Gullickson, 2016 WL 6473215 at *6 (N.D. Cal. Nov. 2, 2016) (quoting Wong v. Tenneco, Inc., 39 Cal. 3d 126, 135 (1985)).

Bart St. III v. ACC EnterprisesApplying this principle, a number of federal courts have refused to enforce contracts relating to state-legal cannabis. For instance, in Bart St. III v. ACC Enterprises, LLC, No. 217CV00083GMNVCF, 2020 WL 1638329 (D. Nev. Apr. 1, 2020), the parties entered into a loan agreement wherein the plaintiff-lender, Bart Street III, loaned the defendant cannabis cultivators in Nevada approximately $4.7 million to fund operating costs, pay down debts and purchase land for a cannabis cultivation facility in Nevada. Id. at *1-2. The loan agreement specified that it was governed by Nevada law. The cannabis cultivators defaulted on the loan, and Bart Street III sued for breach of contract and unjust enrichment. The cannabis cultivators argued that they could not be liable for breach of a contract that is illegal under the Controlled Substances Act of 1970, as amended (the CSA). Id. A federal judge in Nevada ruled that certain provisions of the loan agreement (i.e., a right of first refusal provision and another provision concerning disbursement of operating costs) were illegal under federal law and could not be enforced. The judge was unable to decide on summary judgment whether the illegal provisions could be severed from the other parts of the agreement, so on that basis the cannabis cultivators’ summary judgment motion was denied as to the breach of contract claim. However, the judge granted the cannabis cultivators’ motion as to the unjust enrichment claim based on the following reasoning: “Plaintiff cannot prevail for unjust enrichment because the parties’ contract involves moral turpitude. If the Contract is unenforceable, it is because Plaintiff invested in Defendants’ marijuana cultivation business primarily to obtain a pathway to an equity investment therein . . . . Providing funds in exchange for equity violates the CSA because it would allow the investor to profit from the cultivation, possession, and sale of marijuana . . . . Conspiracy to cultivate marijuana is a crime of moral turpitude.”

Polk v. GontmakherThe illegality defense was also raised in Polk v. Gontmakher, No. 2:18-CV-01434-RAJ, 2020 WL 2572536 (W.D. Wash. May 21, 2020), which involved two business partners—Polk and Gontmakher— who owned a licensed cannabis processing facility and retail store through an entity called NWCS. When Polk decided to leave the business, Gontmakher refused to acknowledge Polk’s ownership interest because Polk had a prior criminal record, which violated ownership requirements for cannabis businesses under Washington cannabis regulations. Polk sued Gontmakher for breach of a verbal partnership agreement and sought to recover past and future profits of the cannabis business. Gontmakher moved to dismiss, and the district judge granted the motion: “Mr. Polk’s claim that his requested relief would not require a violation of the CSA defies logic. He is demanding the future profits of a business that produces and processes marijuana in violation of federal law. How does Mr. Polk anticipate NWCS will generate these future profits? The Court cannot fathom how ordering [Gontmakher] to turn over the future profits of a marijuana business would not require them to violate the CSA. And as this Court has previously explained to Mr. Polk, it cannot award him an equitable interest in NWCS because to do so would directly contravene federal law.” Polk, WL 2572536 at *2.

J. Lilly, LLC v. Clearspan Fabric Structures Int’l, Inc.Certain federal district court judges have addressed the illegality defense directly, even when it has not been asserted by the parties. In J. Lilly, LLC v. Clearspan Fabric Structures Int’l, Inc., No. 3:18-CV-01104-HZ, 2020 WL 1855190 (D. Or. Apr. 13, 2020), a licensed cannabis cultivator in Oregon contracted with Clearspan, a lessor of commercial greenhouse equipment located in Connecticut, to lease greenhouse equipment for the facility and also have the facility constructed. After construction began, the cultivator notified Clearspan (and the sub-contractor) of numerous defects in the facility that were impeding cultivation efforts, and after Clearspan allegedly fixed only one defect, the cultivator sued for breach of the agreements and claimed lost profits due to the inability to cultivate cannabis, in the amount of $5.4 million. While Clearspan moved to dismiss the claims on the basis that the cultivator waived any contractual right to consequential damages, the District Court raised the issue of the illegality of the contracts under federal law sua sponte at oral argument. After supplemental briefing on the issue, the Court held that “awarding Plaintiff damages for lost profits [for the sale of cannabis] would require the Court to compel Defendants to violate the [CSA…and] provides an independent basis to dismiss Plaintiff’s lost profits claim in addition to” the issue of waiver, and other merits issues.  Id. at *11-12.

And in Ricatto v. M3 Innovations Unlimited, Inc., No. 18 CIV. 8404 (KPF), 2019 WL 6681558 (S.D.N.Y. Dec. 6, 2019), Ricato (an investor) and M3 (the intended cannabis operator and licensee) entered into an agreement to purchase a plot of land in California for M3 to develop as a cannabis processing facility. The investor sued to enforce the investment instrument, and M3 moved to dismiss. The court granted M3’s motion to dismiss on other grounds but noted that “it is not readily apparent to the Court that it could [even] enforce such a contract [as] ‘[m]arijuana remains illegal under federal law, even in those states in which medical marijuana has been legalized,’” such as California. Id. at *5, n.4.

Ricatto v. M3 Innovations Unlimited, Inc.However, under some circumstances a federal court may enforce a cannabis contract. In Mann v. Gullickson, Mann loaned Gullickson money to be used in a cannabis-related business. The agreement was governed by California law. When Gullickson defaulted on the promissory note, Mann sued for breach of contract. Gullickson asserted that the contract was illegal under federal law and moved for summary judgment. In an order denying Gullickson’s motion, the court said that “even where contracts concern illegal objects, where it is possible for a court to enforce a contract in a way that does not require illegal conduct, the court is not barred from according such relief.” 2016 WL 6473215, at *7.

Federal courts are wary of parties seeking the enforcement of cannabis contracts. If there is any possibility that the issuance of a court order enforcing the contract would result in a party violating the CSA, federal courts are likely to deny relief.

State Laws Protecting the Enforceability of Cannabis Contracts

At the state level, legislatures in some states that have legalized cannabis for adult use have enacted laws to protect the enforceability of cannabis contracts. These statutes specifically exempt commercial cannabis activities from general laws voiding contracts that are in furtherance of illegal activities. Examples of these state laws include:

Massachusetts: In December 2016, Massachusetts enacted a statute providing that “[c]ontracts pertaining to marijuana enforceable” and providing that contracts entered into by cannabis licensees or their agents, or by landlords of cannabis licensees, “shall not be unenforceable or void exclusively because the actions or conduct permitted pursuant to the license is prohibited by federal law.” (Mass. Gen. Laws ch. 94G, § 10)

California: In January 2019, California enacted a statute providing that “commercial activity relating to medicinal cannabis or adult-use cannabis conducted in compliance with California law and any applicable local standards, requirements, and regulations” shall be deemed the lawful object of a contract and not contrary to law or against public policy, notwithstanding any law that requires all contracts have a “lawful object” under state or federal law. (Cal. Civil Code § 1550.5)

Nevada: In 2016, a ballot initiative was passed in Nevada, which was then codified under state law, declaring “[i]t is the public policy of the People of the State of Nevada that contracts related to the operation of marijuana establishments under this chapter should be enforceable,” and that such contracts “shall not be deemed unenforceable on the basis that the actions or conduct permitted pursuant to the license are prohibited by federal law.” (N.R.S. § 678B.610).

Similar statutes have been enacted in other states, including in Oregon (January 2018), Michigan (December 2018), Illinois (June 2019) and Colorado (January 2020). See Or. Rev. Stat. § 475B.535 (In Oregon, “[a] contract is not unenforceable on the basis that” commercial cannabis activity legal in Oregon is illegal under federal law); Colo. Rev. Stat. § 13-22-601 (similar to Oregon); Mich. Comp. Laws § 333.27960 (Public policy in Michigan is that “…contracts related to the operation of marihuana establishments [are] enforceable.”); 410 Ill. Comp. Stat. § 705/55-75 (similar to Michigan).

However, many states that have legalized cannabis do not have statutes exempting contracts relating to cannabis activities from the illegality defense.

Contracting Tips for Cannabis Companies

Notwithstanding the uncertainty and inherent risks caused by the conflict between federal and state law, there are certain steps parties entering into commercial cannabis agreements can take to protect their contractual rights, including:

  1. Always include a forum selection clause specifying resolution of disputes in state court and waiving any right to remove the dispute to federal court.
  2. If entering into an agreement in a state that has enacted a statutory provision exempting cannabis contracts from the illegality defense, consider selecting that state’s law (as opposed to New York or Delaware law, which are often the jurisdictions of choice for transactional lawyers who don’t know better) in a choice of law provision.
  3. If neither the parties nor the performance of the agreement have any nexus to a state that has enacted a statutory provision protecting the enforceability of cannabis contracts, consider incorporating the contracting entity in one of those states. In the same way that Delaware is the jurisdiction of choice for incorporating most companies, a state like California may on balance be the better choice for cannabis industry participants due to the legal recognition of commercial cannabis activity.
  4. Consider using an arbitration clause in commercial cannabis agreements. These clauses require parties to arbitrate disputes that may arise in connection with the agreement. As a general rule, arbitration is both more efficient and less expensive than litigation, and arbitrators are less likely than federal judges to refuse to enforce an agreement because it relates to federally illegal cannabis activity.

Conclusion

Notwithstanding expanding legalization at the state level, and general federal tolerance of the state-legal cannabis industry, federal courts remain a dangerous place for cannabis companies. If possible, cannabis companies should specify state court (or arbitration) for resolution of disputes in their contracts, and they should choose a state law that expressly excludes cannabis contracts from the illegality doctrine.


References

  1. Cannabis is legal for medical purposes in 33 states plus the District of Columbia; cannabis is legal for adults over 21 in 11 states plus the District of Columbia. Approximately 76.5% of the population of the United States lives in a state with some form of legal cannabis. See https://www.census.gov/data/tables/time-series/demo/popest/2010s-state-total.html#par_textimage_1574439295. This figure excludes Texas, which has a limited medical cannabis program as of this writing. However, if Texas is included, then over 85% of the population lives in a state with some form of legal cannabis.