With the roll out of the Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA“), our California cannabis attorneys see all kinds of agreements between and among licensees. From IP licensing to white labeling to distribution contracts, we’re beginning to see people emerge from the shadows and enter into written agreements with each other, which is undoubtedly for the best given the amount of litigation that already exists in the industry and given the amount of fighting that’s sure to come regarding commercial disputes. Lately though, what we’ve seen a lot of are “pay-to-stay” and slotting fee agreements between cannabis cultivators, manufacturers, distributors, and retailers. In these agreements, cultivators, manufacturers and distributors are locking retailers into contracts for dedicated, prime-time shelf space. The question, though, is whether such agreements are kosher in California and what you need to know to have a reliable, enforceable, pay-to-stay contract.
California is still pretty dynamic when it comes to contracts between licensees. Unlike other states, California hasn’t really broached the subject of massive restrictions on contracts between licensees (the lone exception is the most recent of proposed permanent regulations that attacked IP licensing and white labeling between licensees and non-licensees). Other states are very particular about licensees exerting undue influence over each other via contract when it comes to things like control, term, and the legitimacy of services/goods being provided to the licensee. Here in California, though, the following are pretty much the only contractual restrictions that exist between licensees in the marketplace:
A licensee shall not perform any of the following acts, or permit any of the following acts to be performed by any employee, agent, or contractor of the licensee:
(1) Make any contract in restraint of trade . . .
(3) Make a sale or contract for the sale of cannabis or cannabis products, or to fix a price charged therefor, or discount from, or rebate upon, that price, on the condition, agreement, or understanding that the consumer or purchaser thereof shall not use or deal in the goods, merchandise, machinery, supplies, commodities, or services of a competitor or competitors of the seller, where the effect of that sale, contract, condition, agreement, or understanding may be to substantially lessen competition or tend to create a monopoly in any line of trade or commerce.
(4) Sell any cannabis or cannabis products at less than cost for the purpose of injuring competitors, destroying competition, or misleading or deceiving purchasers or prospective purchasers …
(6) Sell any cannabis or cannabis products at less than the cost thereof to such vendor, or to give away any article or product for the purpose of injuring competitors or destroying competition…
In turn, licensees pretty much have free reign to contract for whatever they want for however long they want without fear of interference from state regulators (so long as such agreements basically don’t amount to anti-competitive behavior). In addition, in case you’re thinking that licensee contracts don’t matter, California already passed legislation ensuring that commercial cannabis contracts are indeed enforceable in state court so that no one is left holding the bag over some illegality defense to performance.
On to slotting fee and pay-to-stay agreements. When you walk into the grocery store, the retailer likely isn’t just arranging products by name or color. In fact, what’s likely going on is that certain shelf space for new products has been negotiated and paid for by a manufacturer. And with good reason. In commodities, especially saturated ones, face time with consumers isn’t great and margins can be really poor and the competition is vast. In California, only cannabis retailers can sell to the public, so it’s hugely important for wholesale and distributor licensees to have good placement on shelf space in dispensaries and on the retailers’ online menus. The slotting fee agreement essentially amounts to the lump sum fee the supplier pays to the retailer to reserve their sacred, strategic shelf space. The pay-to-stay agreement (which can be similar to the slotting fee) typically takes things a step further where it’s instituted after the initial slot and addresses issues for existing products like marketing, promotion, inventory stocking, failure fees, and paying extra to ensure that your competitors don’t get any valuable shelf space near you or at all.
What should go into these contracts? Like any other agreement, if you’re the supplier, you want to fully articulate exactly where your placement will be in the store, how often that placement occurs, your inventory schedule, what happens in the event you cannot deliver on the inventory, what happens if no one wants your product despite its placement, what happens if the retailer (for its own benefit) wants to place another, better performing product in close proximity to yours, and the list goes on and on. Suppliers of cannabis in California should not be paying robust slotting fees to retailers willy-nilly. Even though retailers have a lot of leverage where there are still so few of them and because they’re the only licensees with a daily, face-to-face relationship with the public, if you are a supplier of a recognized brand (or even if you’re consistent with product potency and quality assurance testing), you still have some leverage where many cannabis consumers are still coming to the marketplace trying to decide what they like. The other reason cannabis suppliers shouldn’t be paying super high slotting fees is because the contract could be invalidated not because of the cannabis aspect, but because it’s anti-competitive in nature.
You’ve probably already concluded that the companies that can afford the highest slotting fees are the ones who will make it to the shelves of cannabis retailers in California. And you’re likely not wrong since retailers also have to financially survive in this newly regulated marketplace and slotting fee agreements certainly help to allocate the risk on what products to buy and re-sell (or not). In addition, the bigger cannabis brands may not even face the prospect of these contracts from retailers because the retailers desperately want to carry on them on their shelves anyway. That begs the question then of whether slotting fee agreements and pay-to-stay contracts are actually anti-competitive in violation of MAUCRSA. There’s no doubt that they certainly could be if retailers band together and start to create extremely high, universal slotting fees. Or if suppliers decide to lock up entire dispensaries. The upside, though, can be that retailers are actually more willing to take on new products since they shift liabilities for their failure back to the supplier, the slotting relationship makes product distribution more efficient, and consumers can benefit from lower prices where the retailer can better allocate its risk on investing in the presentation of new products. In any event, state regulators have stayed silent on this practice for now (although the FTC, the sleeping giant of the cannabis world, has debated the subject a good amount).
The bottom line? Unless and until regulators squarely address it or suppliers start to sue over the practice, if you’re presented with or need a fee slotting agreement or a pay-to-stay contract, make sure that you check the box on the details of the relationship. Make sure, too, that you’re avoiding anti-competitive terms and conditions if you want to make hay in California.