Commercial leases for cannabis businesses are a major concern for many of our clients largely because cannabis businesses operate in an industry prohibited under federal law. Generally, contracts that are illegal are unenforceable and there is an argument to be made that any and all cannabis contracts are illegal, at least at the federal level. But a recent Arizona state court shows that state courts are not always receptive to that argument and that a contract that violates federal law is not necessarily unenforceable.
Green Cross Medical, Inc. v. Gally (April 18, 2017) addressed whether a commercial lease with a medical marijuana grow operation in Arizona was enforceable. John Gally owned commercial property in Winslow, Arizona that he leased to Green Cross Medical to operate a medical marijuana dispensary. Two weeks later, Gally sent a letter to Green Cross revoking the lease. At the time Gally terminated the lease, Green Cross had not received the necessary license to operate a dispensary. However, the lease permitted Green Cross to sublease the property and nothing in the lease stated the lease would be terminated if Green Cross did not receive a license to run a dispensary.
Green Cross sued Gally for breach of contract and attempted to obtain a temporary restraining order to prevent Gally from revoking the lease. Gally argued that the lease was illegal and therefore unenforceable because it involved cannabis distribution. The trial court was persuaded by Gally’s argument and ruled that the lease agreement was indeed unenforceable because violated both federal and state law. Based on this, the trial court did not grant Green Cross the restraining order and it denied Green Cross damages for Gally’s having revoked the lease.
Green Cross appealed the trial court’s decision. First, the appeals court determined that Green Cross could seek damages against Gally even though Green Cross did not receive a license to operate a dispensary on the leased property because the right to sublease was a valuable property right. As a result, Green Cross was permitted to seek damages for the loss of the lease.
The appeals court also held that the lease was not illegal on under Arizona law. The court stated that the Arizona Medical Marijuana Act (AMMA) protects rights of dispensaries to enter into commercial leases and that dispensaries have a contractual right to enter into lease agreements with landlords. The appeals court concluded that “[g]iven the language of the AMMA, a court may not void or refuse to enforce a dispensary’s lease with a landlord simply because the dispensary would be supplying marijuana in compliance with the AMMA.”
The appeals court also rejected Gally’s arguments that he as the landlord could face criminal liability under state law because he was facilitating marijuana distribution by leasing property to a cannabis dispensary. The appeals court pointed to the fact that Gally agreed to execute the lease understanding that Green Cross intended to operate in Arizona’s medical market:
We emphasize that nothing in the AMMA requires a landlord to rent a property to a proposed dispensary. Gally was free not to enter into the lease if he was uncomfortable with the proposed use of the Property. But once he chose to do so, he was not free to rescind his contractual commitments without facing potential monetary liability. Accordingly, leasing property to a medical marijuana dispensary that is in compliance with the AMMA is not illegal under Arizona law. Thus, the superior court erred when it found the lease was void and dismissed the complaint seeking damages for the breach.
The appeals court then acknowledged that federal law prohibits distribution of marijuana under the Controlled Substances Act (CSA) and that it is, therefore, illegal under federal law for an Arizona landlord to lease property to a marijuana business. However, the appeals court went on to state this federal illegality “does not render the contract in this case unenforceable under all circumstances.” The court cited to several cases where contracts involving medical marijuana businesses were upheld by courts despite being prohibited under federal law, showing that courts balance the federal government’s interest in enforcing the CSA with states’ interest in permitting the medical use of marijuana.
The appeals court weighed the interests of the federal government and the state of Arizona and held that the lease was not unenforceable simply because it violated the federal CSA. The appeals court explained that federal government enforcement of the CSA against state-compliant marijuana operators had been in flux for years and that the Department of Justice (DOJ) had instructed US Attorneys not to prosecute individuals acting in compliance with the Cole Memo. The court also noted that Congress has prohibited the DOJ from using funds to prosecute people distributing marijuana in compliance with state law. As a side note, that spending provision was recently extended.
The Arizona Appeals Court sent the case back to the trial court to reconsider the facts of the case in light of the appeals court having held that the lease was not unenforceable and that Green Cross may recover damages for Gally’s terminating the lease.
You can find more on cannabis leases here:
- California Cannabis Leases: The 101
- Marijuana Equipment Leases: What You Need to Know
- Cannabis Real Estate 101
- Marijuana Sale-and-Leaseback: Pulling Money From the Land