The year 2018 began with a mixed bag. California, the nation’s most populous state and its most powerful economic engine, finally began issuing licenses to medicinal and adult use commercial cannabis businesses under the state’s new regulatory regime. Days later, the Attorney General issued a memorandum rescinding the 2013 Cole Memo enforcement guidelines, despite indicating to the contrary several months prior. There has since been bipartisan backlash against Mr. Sessions’ decision, and there are now numerous legislative proposals in congress as to how the federal government will move forward with respect to cannabis.
In the meantime, property owners still have to plan for the future, whether that means deciding how to use their property, or whom to rent commercial space to and under what terms. Operators and landlords alike are uncertain what to expect: on the one hand, state governments are issuing cannabis licenses freely; on the other, the federal government is telling its prosecutors to pursue any and all of them as they see fit– regardless of any state’s laws. One strategy for approaching all this uncertainty is by building early termination contingencies into the lease. Below are a few of many contingencies that commercial cannabis landlords and tenants alike should consider including as part of a potential tenancy.
- Federal enforcement actions. This is what keeps state-legal operators up at night and what many legislators are currently trying to protect against. As long as cannabis remains federally illegal in all forms, however, this will remain a risk. One way to potentially mitigate that risk is by allowing for mutual early termination options in the event of any actual or specifically threatened enforcement actions, such as civil asset forfeiture. If the federal government’s goal is for cannabis operations on the premises to cease, then allowing each party an opportunity to force termination of the lease should be helpful.
- Changes in federal law and/or enforcement priorities. Similar to federal enforcement actions, the parties may want to include options to terminate the lease early if something changes at the federal level to an extent that both parties no longer feel comfortable with state law compliance alone. How significant that change would need to be is up to the parties’ negotiations and levels of risk tolerance. For example, while the Cole Memo has been rescinded, the Rohrabacher-Blumenauer amendment protecting state-compliant medicinal operations is still in effect (if only barely), so the recent federal action may not necessarily be cause for parties to end a tenancy.
- Cole Memo priorities as affirmative lease obligations. Just because the Cole Memo has been withdrawn does not make it irrelevant. The Cole Memo is essentially a well-thought-out list of the federal government’s highest priorities for enforcement against cannabis operators, such as preventing sale to minors, diversion to non-cannabis-legal states, and revenue to criminal organizations. Keeping these priorities in the lease as affirmative obligations that the tenant must comply with, and giving the landlord an early termination option if any one is violated, adds an extra layer of protection for both parties and helps further the state’s goal of elevating good actors and sorting out the bad. Also, we’ve already seen some federal prosecutors issue statements to the effect that existing enforcement priorities (i.e. the Cole Memo) will guide future enforcement decisions.
- Change in local laws/nonconforming use designation. Federal enforcement and changes in federal law are not the only things to pay attention to. California law gives cities and counties final say in whether and to what extent cannabis operations will be allowed in their jurisdictions. If something changes in local law, such as a zoning ordinance, and the proposed use becomes nonconforming and unlawful, then whether or not operations have commenced, the parties may want an option to exit the tenancy rather than fight the local government.
- Secured interests. Just as with residential mortgages, contracts supporting secured interests on commercial property often contain “compliance with all laws” provisions. In light of the recent federal action, lenders may be less comfortable with cannabis uses on the property securing their investment, and may be more prone to call the loan due in full, creating a problem for both landlord and tenant. In such event, the landlord may want an option to terminate the lease early without penalty.
We don’t know where the state-vs-federal conflict will go from here, and for now the cannabis industry will have to continue dealing with uncertainty. So far it seems the market is betting on the states to come out ahead. In the meantime, there are some meaningful items to include in a commercial cannabis lease that may mitigate some uncertainty and risk.