Doing Business with Pot Businesses #2: Cannabis Business Contracts

Put your cannabis contracts in writing, preferably on paper, not stone.
Put your cannabis contracts in writing, preferably on paper, not stone.

The best cannabis contracts are those that never need to be enforced. The most important goal in contract negotiation is for the parties to determine their obligations and when those obligations are due to each other. Everything else is secondary.

That said, things can and do go wrong in business transactions. Maybe a party tries to back out of the deal. More common is that the circumstances surrounding the deal change and the parties cannot agree on which side was to bear the risk of the change in circumstances. One thing leads to another, and we have litigation. Costly litigation.

In this second post in our series on marijuana issues for companies outside of the industry, I am going to look at contracts. Are contracts with marijuana companies enforceable? Should any specific terms be included in those contracts?

Marijuana contracts in litigation raise some interesting questions for judges. There’s a general rule in contract law that illegal contracts are unenforceable. Specifically, if a contract is for an illegal purpose or flows from an illegal act, a court will leave the parties as it finds them. In the states where we work, marijuana is legal at the state level, but it is illegal at the federal level. Does that make contracts with marijuana companies “illegal” for purposes of contract enforcement?

Probably not. Though it hasn’t been dealt with at the appellate level, trial level courts in a number of states, including California and Washington, have upheld the enforceability of contracts with marijuana companies. Leases, promissory notes, and other agreements have been reviewed by judges and those judges have tended to agree that state law bars on enforcing illegal contracts are meant to apply specifically to contracts that stem from acts that are illegal under state law. This is logical, as contract law is a creature of state law, not federal law. Even if a federal court were able to weigh in, under the Erie doctrine, the federal courts would likely follow state court rules, or their reasonable interpretation of what the state court rule would be.

Assuming for the moment that contracts with marijuana companies are enforceable, there are a few conditions that businesses on the other side of a contract with a marijuana business should insert. Primarily, the contracting party should require compliance with state regulations and adherence to the federal enforcement priorities under the Cole Memo. Though it is unlikely that a state’s marijuana regulatory agency has jurisdiction over the actions of unlicensed companies, it still makes sense to require any cannabis business with which you do business to comply with state rules. As long as marijuana remains federally illegal, anyone involved at all in the cannabis industry needs to assume that the federal government is just waiting for a reason to come in and enforce federal law. Though the federal government generally leaves state-legal actors alone, as soon as a marijuana company violates state law, it is at risk of federal enforcement. As a non-marijuana company, you certainly do not want to get caught up in that wake, so the ability to sever ties with actors violating state law is a must have in any contract.

A more subtle term that businesses may want to include in their contracts with marijuana companies is one putting the risk of regulatory change on the marijuana company. To illustrate, let’s say that a marijuana processor contracts with someone in Nevada to purchase lithium batteries for vapor pens. The Nevada company buys those from a Chinese company, relying on the cash it will receive from the marijuana company to pay for the batteries and additional profit. During shipment, the marijuana company’s state regulators ban the purchase or sale of vapor pens by marijuana processors. Without contract terms mandating that one party or the other bear the risk of regulatory change, the parties would be in turmoil. A well-written contract though would could probably prevent litigation by stating clearly exactly what happens in that situation. Non-marijuana companies generally do not want to be left holding the bag when state regulators change pot laws, and it happens more often than one might think.

In the end, marijuana company contracts are not that different from standard business agreements, but there are a few extra things to keep in mind. If you do your homework and try to predict problems before they arise, you can put yourself in the best position to cope with any situations that may come up.