California Cannabis Leases and Licensing Timelines

California cannabis leaseCalifornia is in the middle of building a massive regulatory structure for licensing medical cannabis businesses. Though we already knew that the state will be giving priority review to existing collectives “in operation and in good standing with the local jurisdiction by January 1, 2016,” last week, we learned from the state’s chief cannabis regulator that California will be issuing temporary licenses this fall to applicants with prior local approval. This is ahead of the state’s January 1, 2018 deadline to generally begin accepting license applications, and it highlights the importance of gearing up as soon as possible. The first steps for that involve securing property to lease.

We have written about some nuances in lease provisions for commercial cannabis tenants in California, but the state’s rapid timeline for licensing creates some unique problems. Here then are a few things you should consider including in your California commercial cannabis lease to address uncertainty in licensing and to help streamline the licensure process:

  1. Clearly and narrowly define the permitted use and the controlling law. It’s important to restrict the use of the property and to establish boundaries for indemnification purposes, and particularly important for laying out the basis for complying with applicable local law as a precursor to applying for a state license. The proposed regulations under the Medical Cannabis Regulation and Safety Act (“MCRSA”) require tenant applicants to demonstrate they have the right to conduct their specific proposed business activity on the premises, as demonstrated by a lease agreement. MCRSA also requires proof of approval from the local government. Lease language should include obligations to use the premises only in conformance with the specific regulations applicable to the tenant’s proposed use and in accordance with the terms of the local permit or other approval, as well as with all local laws.
  2. Mandate local approval from the get-go. Though a state-issued cannabis license is more of a forward-looking proposition at this point, local approval can and should be sought before the parties put pen to paper on their lease agreement. A common mistake is for a tenant to invest in a cannabis facility build-out or start buying equipment and supplies before getting all necessary local inspections and permits, or before confirming compliance with zoning and land use laws. The lack of building permits is a classic basis for a municipality’s after-the-fact decision to label a tenant’s cannabis business a nonconforming use (for more on recent California land use disputes, see here). The bottom line is that the parties need to know ahead of time whether the locality will allow the use, and if so, exactly which existing and proposed local laws the tenant will be expected to follow. The lease should prohibit the tenant from engaging in any cannabis activity without express written approval from the locality, preferably through a permit.
  3. Lay out a state license application timeline. California has said that it will begin accepting license applications as of January 1, 2018, but it has also confirmed that it will accept applications for temporary licenses as early as this coming fall. The lease should therefore contain an obligation for the tenant to begin the state application process for the specific type of license sought, upon its execution. Proposed regulations for some types of licenses allow the applicant to continue operating if it was operating in compliance with local law prior to January 1, 2018 and has submitted its application to the state before July 2, 2018. The parties may carve out an allowance for such a scenario, but they should also include an obligation to secure a state license by a certain date or the lease may be null and voice.
  4. Assign responsibility for application costs. Tenant applicants can expect to incur standard license application fees and costs, but under the proposed regulations, certain applicants will need to demonstrate compliance with California environmental laws, either through certification by the local permitting entity, or if no local permitting system exists, then through an environmental impact report (EIR) commissioned by the tenant. The lease should set out a timeline for an anticipated EIR, if one is necessary, and should clarify that all such costs shall be borne by the tenant.
  5. Include an out for failure to obtain a license. In line with number 4 above, if the tenant ultimately fails to acquire a state license under the timeline in the lease, then, regardless of the reason for the failure, both parties will want to be relieved of their lease obligations. The tenant will be unable to collect revenue for rent, and the landlord will not want to be stuck with a non-paying tenant. The lease should include failure to obtain a license within a certain period of time as an event of default.

California is still in unchartered territory as it seeks to create and implement a complex regulatory structure over the country’s oldest and largest cannabis business ecosystem, and it remains to be seen what the final rules for medical will look like, and how they will reconcile with the yet-to-be-released rules for adult use cannabis. But in the meantime, cannabis entities seeking to be the first participants in the regulated marketplace (and their landlords) need to carefully consider how their lease relationship is going to be affected by the licensing process.