With nine states poised to legalize cannabis next month, an increasing number of our clients are seeking help on taking their cannabis business national. They want to know what it will take to cross states with their cannabis cultivation centers, their cannabis retail storefronts or even just with their brand names. If you too are looking to present your cannabis business on a national stage, you need to consider the following seven things:
1. Federal enforcement policies versus federal law. Though the 2013 Cole Memo tells you what the Feds are thinking, you should not forget that there are plenty of other federal enforcement memos that show federal government ambivalence towards cannabis. The first federal marijuana enforcement memo issued in 2009 by then U.S. Deputy Attorney General David W. Ogden essentially said that U.S. Attorneys didn’t have to waste time, resources, and manpower on pursuing medical cannabis operators in “clear and unambiguous compliance” with state medical marijuana laws. But in 2011 U.S. Attorney General James M. Cole (author of the 2013 Cole Memo) issued a memo which didn’t exactly retract the Ogden Memo but made clear the federal government would not stop pursuing MMJ operators in compliance with their state’s medical cannabis laws. Cole then came back in 2013 and told U.S. attorneys that the Department of Justice would focus on eight enforcement priorities and essentially lay off legalized states with “robust” cannabis regulations. None of these memos specifically address what the feds will do with those who operate marijuana businesses in multiple states. Though the 2013 Cole Memo said that the size of a marijuana enterprise alone is not the deciding factor in whether to go after it, we still sense that interstate actors are more likely to draw federal attention.
2. State laws and rules vary (greatly) from state to state. State laws and rules differ greatly on who can own or invest in a cannabis business. Applying for a cannabis business license usually means you addressing three fundamental threshold issues: residency, criminal background checks, and financing rules and all the marijuana-friendly states treat all three areas differently. For example, in Washington State, unless you’re making a loan or a gift, if you want to finance or own a marijuana business you and your spouse must have resided in the state for at least six months. But Oregon has no residency requirement for cannabis ownership or investment. And if Proposition 64 passes in California, applicant businesses “shall not be considered [residents] if any person controlling the entity cannot demonstrate continuous California residency from and before January 1, 2015.” But even without meeting residency requirements, it is still possible for you or your business to enter a “foreign” state via appropriately crafted licensing agreements.
3. IP licensing. Because it is difficult, and sometimes legally impossible, to operate a cannabis businesses across state lines, our clients frequently employ IP licensing agreements. Such agreements allow them to extend their brands and/or know-how beyond their home states. However, the current state-by-state patchwork of marijuana laws greatly complicates these licensing agreements and mandates they be tailored to the laws of the relevant states. Ownership of IP in the cannabis industry is a tricky issue because the USPTO will not issue federal trademark registrations for cannabis-related marks. However, it is often possible to obtain state trademark rights for cannabis goods and services states that permit medical and/or recreational cannabis. Our cannabis IP lawyers have seen far too many ineffective and flat out dangerous cannabis licensing agreements that fail to recognize restrictions on both the licensor’s control over the licensee and how the licensee pays the licensor to use the IP. Licensing agreements can be a great way for a marijuana business in one state to monetize its know-how or IP in another state, but doing these deals incorrectly can cause you to lose your license or your IP, not get paid, or put you at criminal risk.
4. Franchising. Though technically possible, marijuana franchises are generally not worthwhile option for cannabis businesses. First, states like Washington have control provisions that require state residency for those that exert management authority over a cannabis business. Additionally, robust state franchisee protections and onerous rules from the Federal Trade Commission make compliance for franchisors extremely expensive. Under the FTC’s rules, there are three elements of a franchise:
— The franchisee obtains the right to operate a business that is identified or associated with the franchisor’s trademark.
— The franchisor will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation.
— The franchisee has to make required payments as a condition of obtaining or commencing operation of the franchise.
The above may sound like a standard trademark licensing deal, but the difference between a licensing and a franchise arrangement hinges on the franchisor/licensor’s exertion of control over the franchisee/licensee’s method of operation. In a trademark licensing agreement, the licensor will have some control over the use of the trademark – i.e. what products the mark can be used on, the quality of those products, advertising placement, sizing, color, etc. But in a traditional trademark licensing deal, the licensor will not have control over the licensee’s general business operations – i.e. accounting practices, personnel policies, etc. Unless you intentionally creating a franchise and are willing to bear the expense of compliance, it is critical that your deal avoids an inadvertent marijuana franchise.
5. Real estate and local laws. When crossing state borders, you also need to pay close attention to real estate and local laws. States have ceded some control over marijuana businesses to cities and counties and you will be hard-pressed to find a state that does not allow its city and counties to limit or even prohibit marijuana businesses. This means you need to know the local licensing and permitting and zoning laws in the jurisdictions in which you’re planning to set up your cannabis business.
6. Banking. Banking access varies significantly among the cannabis legal states. It is hard to justify any type of cross-state investment if the target company does not have access to banking services. And not all banks are equal. It is possible to open accounts at some large financial institutions that either don’t do sufficient due diligence or actively look the other way when opening accounts. But those accounts are subject to closure any time the financial institution does a standard account audit. In the long term, an account at a bank or credit union that openly does business with the cannabis industry and complies with its Bank Secrecy Act obligations is a safer bet.
7. Multi-state income taxation. Whether you’re going to cross state borders via a licensing agreement or by operating the marijuana businesses yourself, you are going to be subject to multi-state income taxation. Licensors, owners, and investors need to be aware that the income they receive from a cannabis enterprise is probably subject to income tax in the state from which they receive that income. Each state typically imposes income tax on any businesses with a continuous and systematic economic contact with that state or its residents. This contact is called “economic nexus” and it does not require a company to have a physical presence in the state, such as an office or employees. Since each state’s tax laws are unique, you should know the tax laws of every state in which you are doing or thinking of doing business.