In this article:
- The Use (and Misuse) of Development Agreements in the Cannabis Industry
- Basics of Development Agreement Laws, and What They Mean for the Marijuana Industry
- Key Terms for a Development Agreement Negotiations Related to California Cannabis Use
The Use (and Misuse) of Development Agreements in the Cannabis Industry
Development agreements have become a popular tool for California municipalities regulating commercial cannabis activities. We’ve talked a bit about development agreements in the cannabis context here. In a nutshell, a development agreement is a contract between a municipality and developer that freezes applicable rules, regulations, and policies pertaining to a property at the time of execution. Our California cannabis real estate and land use lawyers have come across quite a few of them lately. Unfortunately, many times local jurisdictions are misusing them at the industry’s expense.
Development agreement laws were enacted to provide assurances to developers faced with uncertainty in government approval processes for complex and long-term development projects. A development agreement should provide developers with assurances that the developer will see a return on investment by providing vested rights to engage in a particular use on a property. The rights are locked in so that if local laws change in the future (e.g., the voters or legislative body prohibit a particular use), the uses permitted in the agreement can continue for the remaining term of the agreement.
The scant authority dealing with development agreements focuses on the broad purpose of the statute to provide assurances to developers as soon as project commitments must be made. Santa Margarita Area Residents Together v. San Luis Obispo County (2000) 84 Cal.App.4th 221, 230.
Development agreements allow municipalities to impose fees without having to deal with the uncertainty and expense of putting the matter before voters (as required with the imposition of a tax), and to negotiate community benefits and public improvements to be provided by developers. They also put municipalities in privity of contract with developers, providing an additional degree of control and remedies for each party that would not otherwise exist.
In the context of cannabis, we are seeing a perversion of the intent of California’s development agreement statutes. Many municipalities require development agreements for commercial cannabis activity regardless of whether there is actual land development involved. The terms are incredibly short (often only 1 to 5 years), the fees are substantial, and developers are not expressly provided with vested rights to operate. In other words, most of cannabis-related development agreements fail to provide developers with assurances that they will see a return on their investment.
Further, the vast majority of municipalities do not allow any negotiation of commercial cannabis development agreements, which calls into question the validity of any associated fees. After all, the justification for exempting development agreements from the constitutional and statutory requirements applicable to municipal fees and taxes is that the terms are bargained for between the parties.
Basics of Development Agreement Laws, and What They Mean for the Marijuana Industry
California’s development agreement statutes are located in Government Code sections 65864 – 65869.5. According to the legislative findings and declarations, the lack of certainty in the approval of development projects can result in a waste of resources, escalate the cost of housing and other development to the consumer, and discourage investment in and commitment to comprehensive planning which would make maximum efficient utilization of resources at the least economic cost to the public. Cal. Gov’t Code § 65864(a).
Providing assurance to development project applications that, upon approval of a project, the applicant may proceed in accordance with existing policies, rules and regulations, and subject to conditions of approval, strengthens the public planning process, encourages private participation in comprehensive planning, and reduces the economic costs of development. Cal. Gov’t Code § 65864(b). In other words, the California State Legislature has determined that providing certainty and predictability in the development process is good for everyone.
Government Code section 65865(a) provides that anyone with a legal or equitable interest in real property may enter into a development agreement with a city or county for the development of the property.
“Development” is not defined in the development agreement statutes, but “development project” is defined in a subsequent chapter as any project undertaken for the purpose of development, including a project involving the issuance of a permit for construction or reconstruction, but not a permit to operate. Cal. Gov’t Code § 66000. Accordingly, a cannabis business that obtains permits for tenant improvements would fall under this definition, but a development agreement would likely not be appropriate where a cannabis business enters a turn-key facility that requires no construction. In practice, this does not seem to be the case, and we’ve seen cities require development agreements where no construction is contemplated.
The development agreement process begins with the local agency’s procedures for development agreements. If none exist, a city or county must adopt procedures upon the request of an applicant, at the applicant’s expense. Cal. Gov’t Code § 65865(c).
The development agreement statutes provide minimum standards for local procedures and requirements, including periodic review of the agreements at least once every twelve months, specification of the duration of the agreement, the permitted uses of the property, the density or intensity of use, the maximum height and size of proposed buildings, and provisions for reservation or dedication of land for public purposes. Cal. Gov’t Code §§ 65865.1-65865.2
A development agreement is a legislative act that must be approved by ordinance and is subject to referendum. Cal. Gov. Code § 65867.5(a). A noticed public hearing by both the planning agency and by the city council are required before a development agreement is approved. See Cal. Gov’t Code § 65867. A development agreement cannot be approved unless the legislative body finds that the provisions of the agreement are consistent with the general plan and any applicable specific plan. Cal. Gov. Code, § 65867.5(b). Like all other ordinances, the ordinance approving the development agreement must go through a two-reading process, with at least a five-day intervening period. See Cal. Gov’t Code § 36934. A development agreement cannot legally take effect until after the 30-day period for a referendum expires. See Cal. Elect. Code § 9141; Referendum Committee v. City of Hermosa Beach, 184 Cal. App. 3d 152 (1986); Midway Orchards v. County of Butte, 220 Cal. App. 3d 765 (1990).
In practice, all of this means that the development agreement approval process takes a substantial amount of time. First, the developer and local government need to negotiate essential terms. Once the terms have been negotiated, the agreement is placed on the planning commission calendar for hearing, followed by two separate city council meetings. Only after the referendum period has expired can the agreement become effective. In a best case scenario, this process may take 90 days. It often takes much longer.
Development agreements in California are rarely challenged, and when challenged, development agreements are usually upheld because the statutes are liberally construed to encompass agreements that substantially comply with their specific terms and conditions and achieve their essential objectives. Santa Margarita Area Residents Together v. San Luis Obispo County (2000) 84 Cal.App.4th 221, 228.
However, given the popularity of use of development agreements in the California cannabis industry, we anticipate seeing an increase in legal challenges, especially where the agreements are mandatory, require substantial fees, have short terms, and lack any connection with construction.
Key Terms for a Development Agreement Negotiations Related to California Cannabis Use
As we’ve explained, California’s development agreement laws were enacted to provide assurances to developers faced with uncertainty in government approval processes for complex and long-term development projects. A development agreement should provide developers with assurances that the developer will see a return on investment by providing vested rights to engage in a particular use on a property. The rights are locked in so that if local laws change in the future (e.g., the voters or legislative body prohibit a particular use), the uses permitted in the agreement can continue for the remaining term of the agreement.
Accordingly, one of the fundamental terms of a development agreement is its duration. Commonly, development agreements in the non-cannabis context provide vested rights for a period of ten to twenty years. Properly building out a facility tailored for commercial cannabis uses may cost millions to tens of millions of dollars. If the term of a development agreement is only one to five years (as many California public agencies are proposing), a developer will not likely recoup the value of his or her investment. Imagine investing $15 million into a state-of-the-art cultivation and manufacturing facility, only to be prohibited from engaging in commercial cannabis activity one year down the road. Don’t go in for a short-term agreement!
Another key term of a development agreement is the description of permitted uses at the property. This clause should be given careful attention, and must be drafted to ensure that all of the contemplated uses of the property are explicitly spelled out. Stating “commercial cannabis activity” without referring to specific categories or license types will lead to confusion and potential problems. If the developer wants to engage in manufacturing, cultivation, and distribution, for example, then all of those uses should be described with as much specificity as possible to ensure that there is no question as to what the public agency authorized.
Many developers want to include uses that the local jurisdiction has not yet authorized. For example, a local jurisdiction may currently allow cultivation and manufacturing, but no retail use. A developer might want to engage in retail use at some point down the road, and therefore want to include retail in the permitted use clause. However, while a developer can commit to uses more restrictive than those set forth in the zoning ordinance, a development agreement may not allow uses or create exceptions to use restrictions beyond those allowed in the zoning code; to do so requires a rezoning or amendment to the zoning ordinance. Neighbors in Support of Appropriate Land Use v County of Tuolumne (2007) 157 Cal. App. 4th 997, 1015. Once the zoning code is amended, the developer can apply to amend the development agreement accordingly.
Another fundamental aspect of a development agreement is the provision of vested rights to the developer. A “vested right” is a right to proceed with construction or other land use activity despite an intervening change in the law. See Avco Community Developers, Inc. v South Coast Reg’l Comm’n (1976) 17 C3d 785. Obtaining vested rights is essentially the entire point of a development agreement. However, we have seen some cities attempt to expressly prohibit developers from obtaining a vested right to engage in commercial cannabis activity. A development agreement should explicitly grant vested rights to the developer, and the vesting should not be conditioned on unreasonable or unattainable benchmarks.
Notice and Cure Period
Development agreements should provide developers with an adequate notice and cure period to enable the developer to remedy any problems and maintain its rights under the agreement before the public agency has the right to terminate. Vested rights under a development agreement are a valuable asset to the property, and developers (and their lenders, if applicable) need to have an opportunity to cure any potential defect and remain in good standing with the public agency to protect the value of the property.
A development agreement should provide developers with the right, but not the obligation, to develop and use a property. Similarly, a development agreement should not require the developer to pay fees for a use it does not pursue. Many development agreements we have seen purport to require developers to pay fees to the public agency even when the cannabis uses are not actually pursued by the developer.
Some public agencies require developers to include a construction schedule in the development agreement. If the public agency insists on such a provision, make sure that the proposed schedule provides maximum discretion and control to the developer, is realistic and attainable, and does not penalize developer for failing to reach certain construction milestones. Construction is riddled with unforeseeable delays, which means there is a strong chance of running afoul of the development agreement terms or having to amend the development agreement if a strict construction schedule is spelled out in the agreement.
This post is not exhaustive, and you should consult with an experienced cannabis real estate attorney before negotiating a development agreement related to this highly dynamic industry in California.