A Close Look at the Arizona Draft Social Equity Regulations

The Arizona Department of Health Services (the “Department”), which is the cannabis regulatory authority in Arizona, released the draft regulations for the Social Equity Opportunity Program (“SEOP”). Click here to view the draft regulations.

Under the SEOP, Arizona will issue another 26 licenses. As set forth in the Arizona Revised Statutes (“A.R.S.”), the SEOP regulations are for:

The creation and implementation of a social equity ownership program to promote the ownership and operation of marijuana establishments…by individuals from communities disproportionately impacted by the enforcement of previous marijuana laws. A.R.S. § 36-2854(A)(9).

Beyond the foregoing, there is not much information regarding the SEOP in the statutes. So, have the draft regulations furthered this stated goal, which was approved by the voters of Arizona? It seems like there may be other ways to promote the intended goal of the SEOP.

Reduction in Licensing Fees

Let’s start with the good news. Under the adult-use program, the initial licensing fee is $25,000. However, the Department has now proposed that the initial SEOP licensing fee would be $5,000. The reduction in fees certainly furthers the goal of “social equity”.

Who May be an Owner, Principal Officer and/or Board Member?

The next issue is who may be an owner, principal officer and/or board member of an SEOP licensee? Before answering that question, the draft regulations require that at least one or more of the principal officers or board members own at least 51% of the equity in the SEOP licensee. A.A.C. § R9-18-303(B)(1) (draft). Seems simple enough.

Not so fast. There are two additional requirements for each principal officer or board member who is part of the 51% ownership group. First, these individuals must petition the court to have any prior marijuana convictions expunged from their record. A.A.C. § R9-18-303(B)(2)(a) (draft). Second, these individuals must have family income in 2019 that does not “exceed two hundred percent of the federal poverty guidelines”. A.A.C. § R9-18-303(B)(2)(b) (draft).

Do the draft regulations require that a principal officer or board member who is part of the 51% ownership group have a prior marijuana conviction? Since this section of the draft regulations is written in conjunctive (see A.A.C. § R9-18-303(B)(2)(a) & (b) (draft)), each element must be satisfied. Thus, it appears that only those principal officers and board members with a prior marijuana conviction who apply for expungement may be part of the 51% ownership group.

Can You Remove a Principal Officer or Board Member?

The next interesting issue is whether a principal officer or board member, who is also part of the 51% ownership group, can be removed from their positions. Typically, an entity’s organic documents (e.g., bylaws, operating agreement, etc.) provide for when a principal officer or board member can be removed from his or her position. However, as part of the SEOP application process, the proposed licensee must provide the Department with documentation that confirms a principal officer or board member, who is also part of the 51% ownership group, cannot be removed from their positions without (a) the written consent of that individual, or (b) a court order removing such individual from his or her position. A.A.C. § R9-18-303(B)(2)(a) & (b) (draft).

While there are other requirements under the SEOP, the foregoing summarizes the material changes from the adult-use program.

How Will This Work?

To help illuminate how the foregoing will work, a hypothetical may help. Let’s assume that Paul, Otto and Tom incorporate a business in Arizona that is called POT, Inc. And, let’s further assume that Paul, Otto and Tom each own 33.3% of POT, Inc. and each will be a principal officer and board member. Paul and Otto each have prior marijuana convictions, and Paul and Tom are millionaires while Otto has been unemployed since 2017. Will POT, Inc. receive an SEOP license? The answer is “no” under the draft regulations. Because only Otto meets the federal poverty guidelines and his ownership interest (33.3%) is less than 51%, POT, Inc. will not qualify as an SEOP licensee.

If we change the hypothetical, so Paul has a prior marijuana conviction and has also been unemployed since 2017, then POT, Inc. would qualify as an SEOP licensee. Under this revised hypothetical, Paul and Otto, who own a combined 66.6% in POT, Inc. meet the requirements under the draft regulations since (a) they have prior marijuana convictions and they can seek expungement, and (b) they both have income levels under the federal poverty guidelines.

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