Cannabis supply chain agreements (e.g., manufacturing agreements, distribution agreements, license agreements, supply agreements) can be difficult enough to draft and negotiate when there are just two parties. The immense amount of over-regulation in the cannabis world can make contract drafting a headache, and even more difficult for attorneys who are not well-versed in cannabis.
That said, cannabis attorneys love complexities. So, over the last two years, our California cannabis attorneys have seen a huge uptick tri-party supply chain agreements. These contracts come up relatively frequently in licensing deals. A brand may want to have branded cannabis products made and distributed to retailers across the state. If the brand wants to use a different manufacturer and distributor, it may be more cost-effective to have one master agreement among all three of them, than to have a separate agreement with both the manufacturer and distributor and force the manufacturer and distributor to enter into a contract with one another. It also may allow the brand more flexibility to have control over how the manufacturer and distributor do business with each other.
Tri-party agreements present a number of challenges that are not present in normal contracts, and I want to address some of the top four issues I regularly see in this post.
1. Party-to-Party Obligations
Parties to tri-party agreements need to be much more specific as to their relationships with one another than they normally would in a two-party contract. Basic contract provisions can lead to massive unintended consequences if not properly considered. For example, if a party agrees to provide a certain service like paying money or delivering goods, it should be very clear which other party the service will be provided to.
While this sounds easy and obvious in theory, it can be pretty tough to address in practice. Parties need to thoroughly consider every obligation and representation and warranty to make sure they are making promises or covenants only to the right party. Imagine, for example, the above IP licensor, distributor, and manufacturer agreement. If the manufacturer had obligations that were intended to be solely to the licensor but were not limited in that way, the distributor could try to claim breach or seek to terminate. This brings me to the next issue.
2. Termination Rights
Tri-party agreements also need to be extremely careful in how they allow parties to terminate. If, for example, one party can terminate based on another party’s breach, where does that leave the innocent, non-terminating party (the one who neither breached nor wants to terminate)? It may be a good idea, depending on the nature of the contract, to limit certain parties’ ability to breach, or to come up with other creative ways to deal with an agreement where only one of the three parties wants out.
On a related note, these agreements should also be very specific as to the effects of termination and what obligations or rights survive termination with respect to each party. It may be a good idea to clarify who has remedies against whom when only one party terminates. And if a contract cuts off any right to receive compensation, it may be good to specify who that cutoff applies to and against.
3. Indemnification
Indemnification is a legal concept that may force one party to a contract to pay certain expenses of another party incurred in a third party action. For example, it’s common for one party to agree to “indemnify” another party if the indemnifying party did something wrongful or breached the contract, and a third party sued the party seeking indemnification. In a tri-party situation, it’s possible that one party’s actions lead to litigation or other harm to both of the other parties, or that two parties’ conduct leads to third-party action against the third. In these cases, indemnification can be incredibly complicated.
Consider the example I have been using above of the manufacturer, distributor, and IP licensor. Imagine that the manufacturer made branded vape pens, the distributor sold them to retailers, and a pen blew up in a consumer’s hand. In a subsequent product-liability action, it’s possible that the consumer would sue the licensor, who didn’t have any part in the manufacture or distribution and who would want to seek indemnification from the manufacturer and distributor. This could lead to disputes just as to who was the proper party to indemnify. This is just one example, and there are countless others.
4. Regulatory Disclosures
Another issue that can cause real headaches for these types of contracts is regulatory disclosures. Any kind of profit-sharing arrangement will make parties “financial interest holders” (FIH) and possibly “owners” under California law. Any time intellectual property is licensed, that could also render one or more parties FIHs or owners. It’s critical to examine these issues at the front end and is a good idea to even spell them out in the contract for clarity. This applies to all contract drafting, but especially so here, because when three or more parties are involved, it’s possible to have multiple different FIH and/or owner relationships going in multiple ways.
This post just scratches the surface of tri-party cannabis contracts. The takeaway should be that these contracts can be incredibly specific and complicated, and that they pose much different risks than normal two-party contracts. For more on this topic, stay tuned to the Canna Law Blog.
