Washington May Redefine What it Means to Own a Marijuana Business

On May 20, 2020, the Washington State Liquor and Cannabis Board (LCB) held a virtual listen and learn forum on Draft Conceptual Rules Regarding Marijuana Licensee True Party of Interest Rules. Cannabis Observer covered the forum and a summary is available here.

The move to change the true party of interest (TPI) rules started in October 2018 when the LCB issued a rulemaking proposal considering changes to WAC 314-55-035, which is home to the current definition of a TPI. This is a big deal because the current TPI definition broadly defines what it means to own a marijuana business and has made it very challenging to own or invest in a Washington marijuana business. This post will examine the landscape in Washington under the current definition of a TPI and what we may see in the near future under these draft rules.

The Current Status of Washington True Parties of Interest

Under WAC 314-55-035, a TPI means any of the following individuals:

True party of interest
Persons to be qualified
Sole proprietorship
Sole proprietor and spouse.
General partnership
All partners and spouses.
Limited partnership, limited liability partnership, or limited liability limited partnership
All general partners and their spouses.
All limited partners and spouses.
Limited liability company
All members and their spouses.
All managers and their spouses.
Privately held corporation
All corporate officers (or persons with equivalent title) and their spouses.
All stockholders and their spouses.
Publicly held corporation
All corporate officers (or persons with equivalent title) and their spouses.
All stockholders and their spouses.
Multilevel ownership structures
All persons and entities that make up the ownership structure (and their spouses).
Any entity or person (inclusive of financiers) that are expecting a percentage of the profits in exchange for a monetary loan or expertise. Financial institutions are not considered true parties of interest.
Any entity or person who is in receipt of, or has the right to receive, a percentage of the gross or net profit from the licensed business during any full or partial calendar or fiscal year.
Any entity or person who exercises control over the licensed business in exchange for money or expertise.
For the purposes of this chapter:
“Gross profit” includes the entire gross receipts from all sales and services made in, upon, or from the licensed business.
“Net profit” means gross sales minus cost of goods sold.
Nonprofit corporations
All individuals and spouses, and entities having membership rights in accordance with the provisions of the articles of incorporation or the bylaws.

A TPI must be vetted and approved by the LCB in order to hold a license. All TPIs must qualify to hold a license, which includes a six-month durational residency requirement. As you can see from the table above, the legal owner of any shares or membership interest in a business is a TPI, along with their spouses.

Currently, there is no de minimis exception to any of this. If you own even .0001% of a marijuana business, you are a TPI and must go through a rigorous application process. If you are a TPI and get married, your new spouse becomes a TPI and therefore must be vetted. If he or she doesn’t qualify then you can no longer be a TPI. An individual or entity can also become a TPI based on business relationships. WAC 314-55-035 also states that anyone who has the right to receive any percentage of the gross or net profits from a licensed business a TPI.

It’s worth noting that in 2019, the Washington Legislature passed HB 1794 which allows marijuana licensees to pay royalty fees of up to 10% of gross sales of specific products as part of intellectual property or trademark licensing agreements. WAC 314-55-035 does not, at least in my opinion, currently make clear that this carve-out exists in the law.

The Draft TPI Rules 

Under the draft rules, a person with an ownership stake (e.g., a member in an LLC) or anyone who has “a right to receive revenue, gross profit, or net profit, or [exercises] control over a licensed business”  will still be a TPI. However, their spouses would not also be considered TPIs solely based on marriage which is a significant change from the current model. “Control” in this context means “the power to independently order, or direct the management, managers, or policies of a licensed business.”

In addition, the draft rules make some carve-outs to the definition of a TPI. These include exceptions for:

  • anyone receiving rent under lease or rental agreement, a person receiving a commission-based bonus in writing for the sale of products (capped at 10%)
  • a person receiving a commission for the sale of a business or real property
  • a consultant receiving a flat or hourly compensation under a written contract
  • a person “with an option to purchase the applied for or licensed business, so long as no money has been paid to the licensee under an option contract or agreement for the purchase or sale of the licensed business, or a business that is applying for a license”
  • any person with a contract for services with a licensed business (e.g., branding or staffing agreements) so long as the licensee retains control.

Many of these provisions codify industry norms. For example, option agreements are commonly used to transfer marijuana businesses where an option holder pays a licensee for a right to buy a license, pending LCB approval of the buyer as a TPI.

The draft rules also expand on how a licensee can notify the LCB when funds are invested in or loaned to a licensed business. The draft rules clarify that a licensee must disclose the source of all funds used by a marijuana business unless the business is reinvesting its own revenues. In addition, the proceeds of a revolving loan that has been vetted within the last three years do not need to be vetted unless the source of funds has changed or the amount of the loan has increased. The draft rules also codify an LCB policy that allows previously approved TPIs to invest or loan their own money to a licensed business, so long as they have notified the LCB. This means the money can be used, pending the LCB’s investigation.

Bottom line 

It’s important to remember that this process is ongoing. These rules are still in draft. The most significant change appears to be the removal of spouses as TPIs. However, the regrettable residency requirement remains in the draft rules and it will continue to restrict ownership of a licensed business to Washingtonians. The LCB claims that this is required by statute, but there is debate as to whether or not the LCB has the authority to remove or limit that requirement. (Take a look at RCW 69.50.331(1)(b)(ii) to judge for yourself). The draft rules also consider even the most remote ownership interest to create a TPI relationship. That still means that every shareholder of a corporation would need to be vetted, regardless of ownership percentage.

We’ll continue to monitor this process and report on new developments.

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