California Cannabis Supply Chain Contracts: Termination

I will continue publishing a series of posts identifying common issues with cannabis supply chain contracts in California over the next few months. If you haven’t already read earlier articles on this topic, I suggest you start with the following:

Today, I want to talk about termination rights. Believe it or not, our California cannabis lawyers have seen a fair amount of cannabis supply chain contracts that don’t even address basic concepts like how long of a term the contract is for, the grounds for termination of a contract, and what happens after termination. I’ll unpack why each of those things is necessary below:

Most supply chain contracts, with the exception of things like a one-time sale of a single good, contemplate a continued relationship over a period of time. If the contract does not fix that amount of time by clearly defining the “term”, there will almost certainly be issues later down the road and getting out of the contract for parties who want to may be challenging.

Another common problem we see with contract terms is how they are renewed. If a contract has a one-year term but does not address renewal, it will end and any additional contract term will be up to the negotiation of the parties. Depending on the party at hand, this could be very bad. For example, lets assume ABC Co. had a one-year term and was buying a certain quantity of goods for $10/each, and that during the term the demand for these goods rose steeply and that getting them elsewhere on the market would cost $15. If the term automatically renewed with the same terms, then ABC Co. would be in luck. If it didn’t renew, it would have to renegotiate the contract, and the supplier would almost certainly demand a higher price.

Renewal or extension of a contract term itself can be tricky. Sometimes it is automatic but subject to one party deciding not to extend it at a fixed point before the original term ends; sometimes it is at one party’s discretion; and sometimes it is subject to both parties’ agreement. In any case, clearly defining how and when to exercise renewal or extension rights. Otherwise, again, disputes crop up.

Next up is defining the events of termination. As noted, we’ve seen many contracts that fail to do this. Some people simply assume that if the other side breaches, they will be able to terminate. In reality, it’s not always that clear, and so clearly defining the grounds on which one party may terminate the contract is essential. Grounds for termination will change substantially from contract to contract and party to party, so use of boilerplate language can be problematic unless it is amended and tailored to each specific contract.

Finally, even many contracts that clearly define a term and the events giving rise to termination fail to clearly explain what happens in the event of termination or expiration of the contract term. This can be a problematic mistake. For example, let’s consider a distribution agreement where ABC Co. engaged XYZ Co. to distribute ABC’s goods, the distribution agreement expires at a fixed point in time, and XYZ still has 100 units of ABC’s products at the time of expiration. What happens to those goods? Is there a sell-off period? Does XYZ have to return them to ABC? Can they even return them under California’s cannabis regulations?

The moral of the story is that a California cannabis supply chain contracts can be problematic if: it doesn’t clearly set a term, explain how it’s renewed, detail grounds for termination, and explain how the parties must act and what rights they have following termination or expiration. Stay tuned to the Canna Law Blog for more updates on California cannabis supply chain agreements.