California’s cannabis laws are a textbook example of what a state shouldn’t do. And one of the best examples of this is California’s distribution licenses. These licenses were unnecessary from the get go, and the recent developments have only made that reality more apparent. It’s time for the state to end distribution licensing and simplify its arcane cannabis laws once and for all.
What are distribution licenses?
Cannabis needs to get from one place to another. Rather than do the obvious thing and let cultivators drive it to manufacturers, for example, our state decided to create the concept of distribution licenses. It wouldn’t make economic sense for the state to create a class of licenses that are just glorified movers, so they decided to give distributors other jobs. They’d collect the cultivation tax from cultivators. They’d collect the excise tax from retailers. They’d remit those taxes to the California Department of Tax and Fee Administration and file periodic reports. They’d arrange for mandatory lab testing for cannabis goods. And they could do other things like store other licensees’ goods. Was this necessary? No. But it’s the system we got.
Early problems for distributors
Early on, many licensees got a separate distribution license or added distribution to their microbusiness. They thought things would be convenient later down the road because they wouldn’t have to rely on third parties. But after a few years, people started to realize this wasn’t worth it. Self-distribution turned out to be unprofitable in many cases, especially further out in the state. Many suppliers started to use larger distributors who could offer bespoke value-adds, like access to a distribution network, consignment distribution, long-range transport, massive storage facilities, or even drumming up sales through their networks. So a lot of the suppliers who got early distribution licenses decided to give them up.
Burner distribution licenses
This brings us to the first big bump in the road for distributors – burner licenses. We recently wrote about burner licenses, so I won’t recount all of those details here. But here is a common scenario – a licensee decides to sell off its distribution license rather than letting it lapse. Someone swoops in to buy it, and then uses it to buy a boatload of cannabis from legal suppliers. That cannabis then disappears into the illegal market. The buyer does this as much as they can before simply abandoning the license. They may net hundreds of thousands, if not millions of dollars with burner licenses. This activity has been a huge burden on the legal market and a stain on the state’s alleged enforcement policies.
Tax shifting and the downstream effects on distributors
Another problem for distribution licenses as a concept was the state’s restructuring of its tax laws. Essentially, the cultivation tax was eliminated, and retailers were given the reins over excise taxes. Initially, this was a win for distributors. You’d be hard-pressed to find a bigger distributor that didn’t owe six or seven figures to the California Department of Tax and Fee Administration (CDTFA). At the same time, the tax restructuring had a pretty devastating effect on retailers and took away one of the main purposes justifying distributors’ existence.
The effect of this restructuring on retailers can’t really be overstated. For years, I’ve heard clients complain about retailers not paying or dragging their feet on payment. Many suppliers and distributors still use handshake agreements, which means that incentives to force debtors to pay (like attorneys’) fees are not usually on the table. The problem of non-payment has skyrocketed this year. Decreased consumer demand is one of the driving factors, but the requirement for retailers to collect, report, and remit the excise tax hasn’t helped at all.
At the same time, the state is losing tons of tax revenue. We’ve helped licensees negotiate payment plans with the CDTFA and are seeing the agency become more aggressive in pursuing unpaid taxes. Much of these tax bills are on distributors for cultivation and excise taxes payable before the state’s tax restructuring. So as we sit here today, the CDTFA is squeezing distributors for money at the same time that more and more retailers are skipping their bills. This isn’t a good recipe for the industry.
Distributors aren’t the only ones who will suffer
The problems I described in the prior section may be one of the reasons that bigger distributors fail. It’s been widely reported that HERBL (one of the state’s biggest distributors) is apparently in the midst of such a crisis. More are sure to follow. And when distributors fail, it’s not just them who suffer. Consider the fact that many distributors do consignment or similar arrangements. For example, a supplier may arrange for a sale to a retailer and have the distributor transport product for them. Or maybe the distributor takes possession of the product (not title) and arranges for sale. In these cases, the distributor often collects money from the retailer, deducts its fee, and then pays the supplier. And often times, payment is on net (delayed) terms.
When a distributor fails, many suppliers will be right in line behind it. Imagine a retailer buys $100,000 of cannabis in one of the above arrangements. The supplier and distributor may both demand payment from the retailer, who understandably would hesitate to pay either party and risk being sued. This will drag out payment and increase litigation costs for everyone involved.
Let’s maybe stop doing this
Having a distribution license type out there is unnecessary. Many states do fine without them. There’s no reason why a cultivator couldn’t drive cannabis from point A to B. There’s no reason why a manufacturer couldn’t arrange for lab testing. Distribution licenses no longer deal with taxes and are no longer as relevant. So why do we still require them? We just shouldn’t.
At the same time, state law is hard to change. California’s cannabis laws were passed via voter initiative, which takes legislative changes off the table for many parts of the law. And convincing enough voters to do something about an issue this obscure would be, well, not likely to happen. The state should still do everything in its power to simplify the process and expand the scope of distribution activities to other licensees. Maybe it would even be possible to authorize all other licensees to conduct distribution themselves without legislative changes (for what it’s worth, I haven’t thought this one out in full yet).
Eliminating distribution licenses will not solve the market’s problems. But it will make it easier for businesses to cut out middle men (if they want!) and make doing business in an already insanely over-regulated industry a little easier. Every single effort the state can make to clear away regulatory red tape will help a lot. So it’s time that the state thought long and hard about getting rid of distribution licenses and simplifying the system.