California Cannabis Leases: The 101

California cannabis leaseWe’ve written before on how commercial leasing for cannabis business is a uniquely different animal that requires special attention beyond a boilerplate commercial lease agreement. The new multi-agency rollout of California’s proposed medical cannabis regulations under the Medical Cannabis Regulation and Safety Act (“MCRSA“), as well as Governor Brown’s recent budget trailer bill to harmonize the MCRSA and Proposition 64 (California’s adult use cannabis initiative), highlight just how complex things could become as part of California’s new licensing regime, and why it’s important you have a commercial lease agreement that protects your interests, particularly if you are the landlord.

Here are a few things you should consider when drafting a medical or adult use cannabis lease in the new frontier of regulated cannabis in California:

  1. Defining the Permitted Use. Since California will have at least 20 different types of cannabis business licenses under the MCRSA and Proposition 64 and since unlicensed activity can lead to revocation or denial of a tenant’s license, your lease should specifically define the business activity the tenant contemplates engaging in on the property and set out an anticipated timeline for the tenant’s license application and eventual licensure. Any deviation from the tenant’s permitted use defined in the lease or any failure to acquire a license should be cause for terminating the lease agreement. Clearly defining the permitted use is also necessary for the tenant as the new MCRSA cannabis regulations require licensee applicants to demonstrate property owner approval for the proposed license type if the license applicant is leasing the space.
  2. Compliance with Local Laws. Though Proposition 64 does not require proof of local approval to qualify for a license, the MCRSA does. And though Governor Brown’s reconciliation bill would require the State work with local governments to determine compliance for both medical and recreational cannabis licensees at some point in the licensing process, if there is no local permitting structure, the cannabis tenant must conduct an Environmental Impact Report (EIR). If the local government does not approve the EIR and/or the EIR determination disallows the tenant’s proposed use, but the tenant has already signed a lease, that’s a problem for both the tenant and the landlord. For these reasons, landlords and tenants need to know any applicable local laws (which change constantly), and their lease for a medical or adult use cannabis tenant should include a provision requiring compliance with specific local laws and setting out what will happen to the lease in the event of a bad EIR.
  3. Compliance with State Laws and Regulations. The MCRSA (in AB 266) mandates that “a person or entity that holds a state license is prohibited from licensure for any other activity … and is prohibited from holding an ownership interest in real property, personal property, or other assets associated with or used in any other license category.” This means individuals with a state license cannot have an ownership interest in any real property held by any other licensee not within their same license category or license combination allowed by the State. Proposition 64 does not have this real property prohibition. And though the State has yet to come out with its Proposition 64 regulations, other existing state regulations must be addressed in a lease for an MCRSA tenant. For example, there are certain security practices and ID badge requirements to which everyone accessing an MCRSA premises must adhere, including the landlord. There can only be one license per location and the licensee in that location cannot sublet to other licensees. MCRSA retailers are only allowed to operate from 6 a.m. to 9 p.m. and their products must be sight-obscured from the public. The premises of MCRSA licensees must have certain security and surveillance and MCRSA licensees must have a general commercial liability insurance policy of at least $1 million. Your MCRSA lease should include provisions addressing all of these state law requirements.
  4. Compliance with Federal Enforcement Priorities. Your cannabis lease should also have provisions requiring compliance with relevant current and future state and federal laws, except to the extent federal law is inconsistent with California cannabis laws. The 2013 Cole Memo is still the most important federal guidance on state-regulated cannabis operators and Attorney General Jeff Sessions has indicated at least some continuing support for it.  Landlords should ensure their tenants comply with the Cole Memo in addition to state and local laws as this best ensures against federal law enforcement action.
  5. Asset Forfeiture and Indemnity. No one can predict how the federal government will approach cannabis enforcement, but one thing is clear: landlords need to do whatever they can to avoid getting caught up in any kind of civil asset forfeiture stemming from a tenant’s federally illegal cannabis activity, even if the activity is otherwise allowed by California law. A prime example of how this can go wrong for landlords is the Harborside case where the landlord was unable to evict her medical cannabis dispensary tenant because it was not violating the lease agreement, which was drafted to be upheld according to California, not federal law. Your cannabis lease should include language requiring that the tenant indemnify the landlord for any enforcement action and making any such action constitute a default under the lease.
  6. Signage and Advertising. Proposition 64 has specific requirements on where, what, and how a cannabis business can advertise and market to the public and a proposed bill would extend these restrictions to medical cannabis businesses under the MCRSA.  Adult use cannabis businesses cannot advertise or market within a 1,000-foot radius of any school, day care center, or playground, nor can they advertise or market “on a billboard or similar advertising device located on an Interstate Highway or State Highway which crosses the border of any other state.” At minimum adult use retail business leases should mandate compliance with Proposition 64’s advertising and marketing restrictions.

Federal cannabis prohibition, coupled with the fluidity of California’s new cannabis laws, makes standard commercial lease agreements dangerous for leases involving cannabis businesses. Your cannabis commercial lease needs to address the realities and multiple legal issues involved with operating a cannabis business and managing a cannabis business tenant.

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California, Real Estate