Residency requirements are used to award rights or privileges to residents of a state in favor of non-residents. Though they’ve long been used by colleges to provide discounted tuition to in-state residents, they’re appearing more recently as a tool states use in the cannabis industry to benefit their own residents. For businesses looking to expand into the California market, residency requirements could be a significant roadblock. In addition, residency requirements could prevent out-of-state investors and foreign investors from obtaining a stake in what is expected to be the largest cannabis market in the world as California looks to legalize recreational cannabis on November 8.
Proposition 64 is up for vote this week and many are already preparing to start a recreational marijuana business in California. Any interested applicants for a state license should be aware that there is a residency requirement under Prop 64 that states as follows:
No licensing authority shall issue or renew a license to any person that cannot demonstrate continuous California residency from or before January 1, 2015. In the case of an applicant or licensee that is an entity, the entity shall not be considered a resident if any person controlling the entity cannot demonstrate continuous California residency from and before January 1, 2015.
This provision is set to expire on December 31, 2019, though the California legislature will have the opportunity to extend it. Note that this essentially creates a three-year residency requirement for California applicants, or longer depending on when an applicant actually submits its application. It is not clear who will be considered a “controlling” person of an entity.
How the residency requirement will apply to out-of-state applicants, as well as any out-of-state investors and other interest holders, will determine how businesses hoping to receive a license under Prop 64 can be structured. Until we receive clear guidance from the state agencies on who qualifies as a “controlling” person, businesses can only do their best to prepare and be ready to pivot if needed. Our cannabis lawyers have dealt with all sorts of residency and controlling person requirements in securing licenses in multiple other states and we will be drawing on that experience in determining how to proceed on behalf of our clients in California.
For those looking on how California will interpret its “controlling” person requirement, Prop 64’s definition of an “applicant” provides some help. Proposition 64 defines an applicant to include the owner or owners of a proposed licensee, with “owner” meaning all persons with an aggregate ownership of 20% or more plus the power to direct the management of control of the licensee. For a publicly traded company, an “owner” includes the CEO, any board member, and persons or entities with aggregate ownership of 20% or more. For a nonprofit entity, an “owner” shall mean the CEO and any board members. If California decision makers decide to follow this interpretation to determine a “controlling” person for purposes of the residency requirement, it will likely capture out-of-state persons with at least 20% aggregate ownership and some sort of control over the entity. As of right now, if we had to predict, we would say that California likely will use these same rules to determine controlling persons for residency purposes as well.
It is also beneficial to compare California’s proposed residency requirement with those in other regulated medical and recreational marijuana states. Both Oregon and Colorado started out with a two-year residency requirement for all applicants, looking back from the date of filing. In contrast, Washington ended up with a six-month residency requirement for all license holders, managers, and interest holders, which captured practically everyone involved in the business. However, all three states have since amended their residency requirement with Oregon completely repealing its residency requirement for both medical and recreational businesses earlier this year. If the approach of these states serves as any indication, California may eventually take a less stringent approach to enforcing its residency requirement. The more states that allow out-of-staters to participate in their cannabis industries, the more other states will feel pressure to do the same.
A final challenge for out-of-state residents interested in entering California is that some California cities and counties have begun adopting their own local residency requirements. For example, a county may require an applicant for a local marijuana permit to demonstrate residency in the county for at least one year prior to the date of application. Taking it a step further, the City of Oakland’s draft cannabis ordinance included a provision that required half of all new permits go to residents of select neighborhoods with a history of higher marijuana-related arrest rates.
If residency requirements become insurmountable under Prop 64, there is still hope for out-of-state businesses and investors. Currently, under the Medical Cannabis Regulation and Safety Act, there is no language creating residency requirements for medical cannabis licensees. But out-of-state residents should still tread carefully. In Oregon, a residency requirement was not included in the original ballot measure but was added by the state’s legislature in a later bill; and the California legislature has been busy proposing “clean up” bills to amend various provisions of the MCRSA (such as SB 837 that made several substantive changes to the original bills). So there is still at least a fair chance California will add a residency requirement for medical cannabis licensees as well.
At this point, it remains unclear how exactly residency requirements will impact California cannabis businesses. But one thing is certain, out-of-state residents and companies with any out-of-state ownership better keep a close eye on developing regulations and rules if they hope to obtain a California cannabis license in 2018.