For years now, I’ve noticed and analyzed a lot of unique cannabis small business relationships across the sector spectrum. Particularly, a lot of proposed and draft agreements have come across my desk detailing the contractual relationships in between a assortment of parties in the cannabis sector for many purposes–from investors, ancillary solutions providers, and licensees to intellectual home holding businesses, gear lessors, and lenders (and additional). Altogether, I’ve noticed lots of unique contractual and corporate set ups inside a assortment of cannabis-friendly states. California, even though. requires the cake on the most bizarre and legally questionable cannabis small business relationships and contract structures and that tends to make sense as California cannabis continues to emerge (sort of gradually) from a gray healthcare industry.

Eventually, when you believe of California’s cannabis marketplace at this point, you can harken back to Rod Serling saying:

You are moving into a land of each shadow and substance, of items and tips. You have just crossed more than into … the Twilight Zone.”

I not too long ago wrote about all the poor behavior that nevertheless happens in California (even with licensing in play) and also about the leading five most risky cannabis contracts in this state, but this post is devoted to these contractual and corporate relationships and structures I’ve noticed most not too long ago in the Golden State that preserve coming up once more and once more. These arrangements either skirt the cannabis guidelines fully, or make zero sense from a contract and/or corporate governance standpoint. So, if you are seeing these agreements and structures in the marketplace and scratching your head, you are not alone.

1.     Unlicensed businesses operating below an additional company’s license.

The quantity of instances I’ve noticed a licensee permit an unlicensed small business to operate inside its premises is rising quickly in California. In most other states, the regulations make abundantly clear that any organization engaged in industrial cannabis activity, no matter what, would call for a cannabis license and that you can’t operate an unlicensed cannabis small business inside the licensed premises of an additional organization. Not so right here in California.

Whether or not it meant to do so or not, the Bureau of Cannabis Manage (BCC) produced a relatively confusing scenario with the adoption of Rule 5032 exactly where it mandates that all industrial cannabis activity can only take place in between licensees but at the exact same time. In its Final Statement of Motives, the BCC also states that unlicensed parties can have white label and/or intellectual home (IP) licensing relationships with licensees so extended as these unlicensed parties are disclosed to the BCC as a economic interest holder. Some parties have taken this a step additional to interpret this rule to imply that an unlicensed organization, so extended as it is disclosed to the BCC in some capacity, can actually operate its personal small business inside/below/by means of a licensed organization, conducting industrial cannabis activity as if the unlicensed organization owns the license. (And items grow to be incredibly confusing from a efficiency obligation viewpoint when one particular of these unlicensed businesses is an equity owner in the licensed small business, but is also acting as, let’s say, a management organization of that licensed small business at the exact same time).

These arrangements, of course, aggressively push boundaries and are untested with the BCC (let alone with neighborhood governments). Nonetheless, I’m seeing these proposed agreements in between licensed and unlicensed parties additional and additional: unlicensed parties basically do not want to or can’t safe their personal licenses, regardless of conducting all the regulated industrial cannabis activity. I have no doubt that as soon as the BCC ultimately flips into enforcement mode that it will begin actually analyzing these relationships to identify who is basically conducting industrial cannabis activity in violation of the guidelines (most likely lots of people).

two.     Licensee contracts with unlicensed parties that operate at a licensed facility.  

These sorts of contracts grow to be increasingly difficult mainly because of quantity 1 above. If you are a licensee and you are getting presented with a contract from an unlicensed celebration that is operating inside an additional company’s licensed premises, you will need to proceed with intense caution.  Even if an unlicensed organization is disclosed below an additional licensee as an “owner” or a “financial interest holder,” that does not imply that that organization can begin undertaking its personal industrial cannabis activity carte blanche.

Recall, industrial cannabis activity can only be carried out in between licensees. That is not to say that an unlicensed organization can’t help a licensee with its industrial cannabis activity, but if that unlicensed organization is inking its personal contracts without having any mention of the actual licensee below which it operates, you are going to have important regulatory troubles in the future (not to mention murky troubles about representations and warranties about compliance with the guidelines, fitness of item, recalls, and so forth.).

The widespread partnership I’m now seeing most normally is exactly where an unlicensed organization is using a cultivation or manufacturing facility and attempting to straight contract with licensed distributors or retailers to get their personal item to industry (exactly where that item, at the exact same time, will include the cultivator’s or manufacturer’s information and facts to satisfy the packaging and labeling guidelines, but will be co-branded with the unlicensed company’s information and facts and intellectual home). With no additional guidance from the BCC, it is not hard to identify that such a contract violates Rule 5032.

three.     IP licensing and white labeling. 

Thanks once more to the BCC, IP licensing with cannabis licensees in California is not at all simple. Whilst unlicensed businesses can license their IP to cannabis licensees as extended as these unlicensed businesses are disclosed as economic interest holders, if they physical exercise as well substantially path, handle, and/or management more than the licensee relative to the IP, the unlicensed organization may well be deemed an “owner” below BCC regulations and that implies disclosure of the unlicensed celebration and maximum scrutiny from the state.

Anybody who’s completed an IP licensing agreement knows that the licensor ordinarily gets substantial handle more than the use of the IP relative to the licensee, so currently we potentially have a dilemma in California exactly where preserving the integrity of the mark “too much” may well make the licensor an “owner” of the cannabis licensee. The exact same concern may well take place with white labeling, exactly where as well substantially handle more than formulations and item compilation could quantity to unlawful “ownership” more than the cannabis licensee.

I am constructive that there are IP licensing and white label and provide agreements in California that have produced secret owners all more than the spot mainly because of the level of handle in these agreements provided to unlicensed parties. The BCC has incredibly small guidance out about these relationships, so its scrutiny of these agreements will most likely be on a case-by-case basis if and when such relationships are found.

four.     Disclosure troubles.

Close to as I can inform when speaking to people, most people today nevertheless do not comprehend or know the extent of owner and economic interest holder disclosures expected by the State of California. What’s for confident, even though, is that specific investors and financiers want to prevent these troubles altogether if they can assist it (which is a lot easier stated than completed). In specific with the BCC, if you are an owner that is an entity, you are disclosing just about every single owner in that entity, even if they personal below 20% of the entity.  This implies you will disclose not only your equity owners at 20% or additional AND all folks in a handle, path, or management positions, but you will also disclose all of your economic interest holders (with incredibly handful of exceptions) that are at 19% or significantly less in equity. (And, yes, this involves disclosure of any investment funds or restricted partners in a common partnership, and just about every particular person or entity inside these structures, as well, if you ask the BCC).

All of this is definitely very problematic for fundraising and M&A and a lot of licensees do not comprehend that they’ll violate the guidelines if they fail to timely make these disclosures. In spite of that reality, I see lots of transactions and cap tables from licensees exactly where they comprehend only when it is as well late that they have to make these robust owner and economic interest holder disclosures or face significant rule violations. And a lot of of these investment agreements and/or M&A transactions do not even mention any sort of default or obligation about these disclosures — which is a enormous drafting error.

five.     Operating without having a provisional license.

For some purpose, some stakeholders are below the impression that they can continue to operate if they have neighborhood authorization but no state license. This is just dead incorrect. And even if you have neighborhood authorization and have applied for an annual license in order to get a provisional license, you nevertheless can’t operate. Just standing in line for a provisional does not make you a legal operator. You have to have each neighborhood authorization and either a provisional or annual license. In carrying out diligence on specific operators, I’m continuing to see expired short-term licensees that do not however have provisional or annual licenses. To purchasers and/or investors of cannabis businesses in California, make confident that your target has each neighborhood authorization and a state license just before pulling the trigger.

California cannabis has specific pitfalls that are as opposed to any other state due to the nascent nature of the licensed sector and ambiguities produced by the regulators. Regrettably, these pitfalls and ambiguities are not getting addressed with further guidance or even constant BCC enforcement. In any occasion, proceed with caution out there and be confident to study the fine print in your proposed agreements and in the guidelines.