Cannabis Litigation

In this article:

Spotting Criminal Law Issues

One of the unfortunate byproducts of cannabis legalization is cannabis litigation. With each passing month of legalization in the states in which our cannabis lawyers operate (California, Oregon, and Washington) we see an increase in disputes. The most common cannabis litigation matters are disputes about medical and recreational grows, disputes between former business partners now going their separate ways, disputes between employees and employers, and cases involving cannabis intellectual property. This is the first in a series of posts I will be writing on cannabis litigation.

Today’s topic is criminal law, which to at least some extent, can permeate civil litigation involving any cannabis business. Criminal law is important in civil cannabis cases because conduct that is perfectly legal under state law may well be illegal under federal law. The risk of federal criminal liability means that a cannabis litigator in a civil case should at least consider whether to rely on the 5th Amendment privilege against self-incrimination, which can be asserted in civil proceedings or in connection with oral testimony, pleadings, or requests to produce documents.

Cannabis litigation

How do evaluate whether to take five, i.e., assert the 5th Amendment? Here is an overview of the three main legal issues to help you analyze whether associating criminal counsel is appropriate in your civil law matter.

Prior statements in a civil cannabis case could be admissions of criminal activity in another case

A large part of every civil case is explaining the facts which support your claims, and which contradict your opponent’s. A civil litigant will make statements about facts in her pleadings, in discovery before trial, or in testimony at trial. You should assume that almost anything a litigant or her lawyer says about facts in a civil case will be admissible in a later criminal proceeding, even if the statement is not made under oath. An example might be the opening allegation in a complaint against a business partner in a grow: “Pursuant to an agreement, plaintiff and defendant worked together to cultivate cannabis crops, which they intended to be sold, and did sell, pursuant to this state’s recreational cannabis laws.” Right there you are probably admitting that you violated federal criminal drug laws.

Does testifying to potentially incriminating facts in the civil case waive the privilege?

Courts have held that waiver of the 5th Amendment privilege in a civil case will not waive the privilege in later criminal proceedings. But the practical effect of this principle is limited. Though a defendant who has waived her privilege in a prior civil case could testify in a later criminal case, any prior incriminating statements she made in the civil case can be used against her, even without her testimony.

Risks of asserting privilege in the civil case

In a criminal case, the fact finder may not infer that a defendant is guilty because she asserted the 5th Amendment. In civil cases, however, a jury may draw negative inferences against a party who declines to testify by relying on the 5th Amendment. So, a lawyer in the civil case might argue to the judge or to the jury: “Plaintiff claimed the privilege when asked whether she grew cannabis. Doesn’t this suggest she did grow cannabis?”

Knowing and evaluating the legal issues is only the first step in deciding whether to assert the 5th Amendment. The more difficult next step is forecasting whether a prosecutor—now or in the future—will choose to bring criminal charges for conduct legal under state law.

In part 2 of my series on cannabis litigation I will discuss how early registration of trademarks and copyrights and protection of your trade secrets can help you both avoid litigation and prevail should it nonetheless be unavoidable.

How Early Registration of Trademarks and Copyrights Can Help You Avoid Litigation

In a 1970s TV commercial, the Fram oil filter pitchman observed that it is cheaper to change your filter than to rebuild your engine: “You can pay me a little now. Or you can pay him (expensive engine rebuilder) a lot later!” This auto maintenance rule also applies to your cannabis business in the area of intellectual property (IP) litigation. Today’s post is on avoiding expensive IP  litigation later by doing preventative maintenance on your IP now.

The first step to protecting your IP is to know that you have it. You may not realize it, but almost every cannabis business has one or more of these kinds of IP assets: trademarks, copyrights, trade secrets, or patents. Even if you’ve never registered your IP, you almost certainly have some combination of the first three IP types, which don’t require registration. But just like your oil filter, you can’t maintain it if you don’t know it is there.

Once you know what you have, the next step is to protect it. Each type of IP is protected differently. Here is an overview that will fit in your glove compartment:Cannabis litigation

Trademarks

Trademarks protect brand names, e.g., “FlyBoy Cannabis,” that signifies you as the source of the goods and services you offer. Although trademark rights are established by the use of the trademark, not registration, you should still register your trademark with state trademark office(s), and the federal trademark office in some cases. Once you’ve registered your trademark, you should tell the world this is your trademark. Using ® is a good first step, but you should also establish a trademark use policy so that your customers consistently link you with your products. Registering your mark makes it easier to protect your brand in court, and will give notice to infringers that your brand belongs to you.

Copyrights

Copyrights protect the expression of a creative idea in a tangible form, not the idea itself. Your copyright applies as soon as your creation goes from your mind into a tangible form, such as writing an article on your computer or creating a CAD drawing of your design. You should take steps, including using the ©, to identify your work as yours. You should also register with the U.S. Copyright Office (don’t bother sending your content to yourself in certified mail). As with trademarks, copyright registration gives you increased protection over your rights. Being able to threaten a lawsuit can be a powerful incentive to convince an infringer to stop instead of litigating.

Trade secrets

Trade secrets are commercial information, including technical and business information, which give you a competitive edge because they are not publicly known. For example, your confidential process for extraction could be a trade secret, so long as it cannot easily be “reverse-engineered.”  The most important step to protect trade secrets is to keep them secret. However, you will likely need to share trade secrets with your own employees, and also with others outside your organization with whom you do business. Thus, nondisclosure agreements are one important feature of a trade secret policy. Depending on your business, you may need to take other steps as well. By the way, you can’t “register” a trade secret.

Patents

Although plants are generally patentable, the U.S. Patent Office traditionally refused to patent DEA Schedule I cannabis plants, though this appears to be changing. But many other inventions that can be used with cannabis could be patentable, such as vaporizers, smoking devices, and test equipment. An inventor has no patent rights until he or she files a patent application with the federal patent office (there are no state patents), and these rights won’t be enforceable, if at all, until the patent is granted, usually several years later.

Formal Operating Agreements and IPs

If you co-own a cannabis business, you probably have a formal operating agreement that sets out who owns what—at least if you’ve been reading this blog. As I noted in my previous blog post, your cannabis company probably owns some intellectual property (IP): trademarks, copyrights, trade secrets, or patents. But who owns the IP, if, as is common, the operating agreement is silent on this issue? You may not have thought much about this, but you should. As any divorce lawyer can tell you, many assumptions about who owns what turns out to be mistaken.

Like any other kind of property, IP is subject to general default rules that establish ownership, at least to begin with. The default owner of a patent is the human inventor. The default owner of a trademark is the entity (human or not) that uses the mark in commerce. Caution: it is easier to state these IP default rules in the abstract than to apply them in the real world. For example, though there is an ownership rule in copyright law called “work for hire,” it turns out it doesn’t apply to many people who are hired to create copyrightable works. Making mistakes about these default rules can lead to disappointment or litigation.

cannabis Intellectual property

You can diminish this risk, however, by making your own IP ownership rules. Virtually all of the default IP rules can be contracted around. A well-drafted IP ownership contract allows the parties to arrange their conduct knowing who will own the resulting IP. It will also discourage those who might try to take advantage of the uncertainty to claim ownership of IP.

Co-owners of a business

IP issues arise in connection with a business formation in at least two situations: (1) some or all of the owners come to the business with preexisting IP, like brand names or trade secrets; and (2) the business will create new IP during operation. An IP agreement can define ownership so that the business will not be left without important assets (such as the brand name of the company) if the partner who brought IP to the business decides to leave. It can also provide ways to protect IP owned by the corporation, such as by requiring inventors to assist with patent filings or assign IP rights.

Deals with other businesses

Many deals between businesses have IP consequences. For example, a joint venture to create new growing processes could result in creating trade secrets or patentable inventions. In a distribution agreement, it is common for one party to have a license to use the other party’s trademarks. Determining the ownership of IP is critical when two companies work together.

Employer/employee/independent contractor

Any time a business entity pays a human being to create something, IP ownership issues will arise. Many businesses assume they know the default rules that apply to depend on whether the human is called an “employee” or an “independent contractor.” The rules distinguishing these categories, however, vary from state to state and are notoriously hard to apply. So, an IP agreement should not turn on the classification of the worker. Having a solid IP ownership agreement will allow both parties to concentrate on creating IP, and will lower the risks of disputes if and when the relationship ends.

IP ownership agreements need not be separate documents. The appropriate language can be included in your cannabis company’s operating agreement or even in its employee handbook. If you really want your own IP, however, don’t rely on the default ownership rules.

Intellectual Property Ownership Agreements

An important question for any cannabis business is: who owns the company’s intellectual property (IP)? The easy way to answer this question is to work it out before any dispute. The much, the much harder way is to litigate. As noted in a famous oil filter commercial, “You can pay me a little now. Or you can pay him a lot later!”

The two most common situations where IP ownership disputes arise in a marijuana business are between the owners of a company, and between the company and its employees. Here are some tips on how to handle each situation.

IP ownership in an entity

IP is a capital asset of a cannabis company, and like all other capital assets, e.g., grow equipment, real property, office furniture, software, etc., should be owned by the cannabis company itself, as provided in the entity operating agreement. Issues can occur, however, when the entity wants to use an IP that is already owned by a member/owner of the entity.

In particular, many operating agreements provide that a member contributes her IP as initial capital. There is nothing wrong with this, in theory. Intellectual property, like real property or other assets, can be contributed as capital provided that the operating agreement properly values and accounts for the asset. But problems can occur when the operating agreement does not legally transfer the title in the IP to the entity. In such a situation, the “contribution” may be more like a license, which can be revoked. If the contributed IP is the primary brand name of the company, this could give the contributing shareholder undue leverage if she wants to withdraw from the entity after the company has built equity in the brand name. A significant number of operating agreements do not properly transfer title to the trademarks, copyrights, or patents that are being contributed. Without the appropriate transfer, this is a time bomb waiting to explode, in a courtroom near you.cannabis marijuana intellectual property

IP ownership of employee creations

The conventional wisdom is that everything that is created by a company’s workers automatically belongs to the company as “work for hire.” While there is a federal copyright statute that refers to works for hire, the rules are much narrower than conventional wisdom suggests. This often causes conflicts between employers and employees about patents and copyrights, which in turn leads to litigation.

There is an easy way to avoid the work-for-hire minefield, called an employee IP agreement (“EIA”). An EIA is a written agreement that defines which creations are the employees, and which are the employers. For example, where a new employee has already created IP before her employment, the EIA could provide that the employee retains title to all disclosed preexisting IP, but is required to assign any future IP created in the scope of her work to the employer. EIAs also often address creations done outside of the workplace or outside of the scope of employment and may provide for invention bonuses or other incentives. The key is that the EIA allows the parties to define their ownership of worker creations, without having to rely on the limited default rules that exist in federal and some state law.

Waiting is the Hardest Part

According to Above the Law, the longest legal case in US history lasted 57 years! Fortunately, your typical state court case will usually be set for trial within one or two years of filing (with exceptions for expedited cases), though some federal cases can take much longer. For example, federal patent litigation cases can take about three years before trial.

Clients almost always have a justifiable sense of urgency when it comes to litigation. It feels like the other side is trampling on their rights, and each passing day brings more legal fees and more damage to the business. Litigation can often make clients feel helpless in the face of a legal system designed to slowly and methodically ferret out the truth.

This sense of urgency is particularly acute when the opposing party’s conduct is actively and irreparably harming your business interests. In these cases when patience is not a viable option, your lawyer will likely discuss the possibility of seeking provisional remedies, specifically temporary restraining orders (“TRO”) and preliminary injunctions.

A party seeking provisional remedies is asking the court to halt certain conduct prior to a full determination on the merits. Since it comes before you win your case, this is an extraordinary remedy, and the burden on the movant is high. Additionally, the purpose of provisional remedies is typically to preserve the status quo, for example, to prevent a landlord from wrongfully evicting a tenant.

The law varies by jurisdiction, and for the purposes of this post, we will focus on Oregon state law. Under Oregon Rule of Civil Procedure 79 (ORCP 79), a party can obtain provisional remedies in a civil action when it appears the movant is entitled to the relief demanded in a complaint and the requested relief involves halting the commission of an act that will cause injury to the movant during the course of the litigation. The movant can ask for a preliminary injunction, or, pursue a TRO if the danger is immediate.

Cannabis litigation

Preliminary Injunctions

A preliminary injunction prohibits the non-movant from taking specific actions that will harm the movant, and the scope of the Court’s authority to craft an appropriate remedy is remarkably broad. A preliminary injunction can even bind non-parties, specifically a party’s “officers, agents, servants, employees, and attorneys and … those persons in active concert or participation with any of them that receive actual notice of the order by personal service or otherwise.”

When considering a preliminary injunction you should be aware of the cost. A hearing on a preliminary injunction is a mini-trial, with both sides presenting witnesses and evidence, and all of the attorney fees and costs that entail. Additionally, even if you prevail you will need to post a bond in an amount set by the Court, based on the Court’s estimate of the potential damages that the injunction will cause to the other party. If you ultimately lose at trial, then the other party will get the full amount of the bond.

Temporary Restraining Orders

In Oregon, you must give the other party at least five days’ notice of the preliminary injunction hearing, so that the parties can prepare their evidence. If you absolutely cannot wait five days, then you can file a motion for TRO and order to show cause why a preliminary injunction should not enter. Given the emergency nature of this type of pleading, it is typically submitted ex parte: the movant will personally appear at the court and hand deliver the pleading and supporting documents to the clerks and will likely speak directly to a judge on the same day. The Court will typically decide whether to issue the TRO based on the affidavits and evidence submitted by the movant on the same day. The non-movant may appear but likely won’t have much of an opportunity to submit contradictory evidence.

The TRO can only last about ten days, so if the TRO is granted, then the Court will quickly set an evidentiary hearing to determine if the TRO should be converted to a preliminary injunction, as described above. As with the preliminary injunction, you will need to enter a bond with the court before the TRO will go into effect.

Seeking provisional remedies is an extraordinary and expensive step, but may prove vital for protecting your cannabis businesses. We have seen it be particularly effective in stopping wayward business managers from stealing company assets and other misconduct. The preliminary injunction procedure can prove to be dispositive, as the result will often drive the parties to settle in one or the other party’s favor.

Dispositive Motions

I will discuss a litigant’s options to bring a quick end to a case via a motion to dismiss or a motion for summary judgment.

These two sorts of motions share many similarities, but this difference is key: motions to dismiss contend that a party’s allegations in its pleadings (complaint or counterclaims) are deficient. A motion for summary judgment requests the court apply the law to the facts a and determine the case is not even worth sending to a jury.

Motions to Dismiss.

You can move to dismiss a claim against you for a variety of reasons including that: 1) the court lacks jurisdiction (legal authority to resolve the present dispute), 2) there is already another action between these parties attempting to resolve the present dispute, 3) the claim was brought outside the statute of limitations, or 4) the claimant failed to state facts sufficient to constitute a claim. Jurisdictional questions focus on whether the claim should have been brought in another state or county, or whether the parties complied with any binding dispute resolution clauses in any relevant contracts, such as mandatory arbitration provisions. A party can also move to dismiss on jurisdictional grounds if service was improper.

On a motion to dismiss for failure to state a claim, the question for the court is not whether the actual facts ultimately support a claim, but whether the pleadings as written support a claim. The party that files the motion to dismiss is asking the court to throw out the case as a whole (or at least certain claims) based solely on the face of the complaint or counterclaims. Essentially, by filing a motion to dismiss you are telling the court, “Even if everything my opponent claims is true, I still win so there is no point in our even continuing with this case.”

On a motion to dismiss the court must assume everything your opponent writes in its claims is true and apply your opponent’s ideal set of facts to the law and decide whether any valid claim exists. Any litigant should be mindful that a successful motion to dismiss for failure to state ultimate facts will not necessarily end the case. The court has broad discretion to allow the non-moving party to amend its pleadings to fix any deficiencies.

Motions for Summary Judgment.

Though motions to dismiss are limited to the four corners of the pleadings, a motion for summary judgment digs into the underlying facts that exist outside the complaint and other pleadings. Motions to dismiss are usually filed pre-discovery, but since motions for summary judgment examine the underlying facts, they are typically brought after the parties have incurred significant expenses in discovery disputes and depositions. The party seeking summary judgment essentially asks the court to look at the evidence produced through the discovery process and rule that no reasonable jury (or another fact finder) could rule in the opponent’s favor. Both sides will submit sworn statements, called affidavits or declarations, laying out their side of the case, and will also submit documents obtained from discovery and deposition transcripts.

The court will review all of this evidence in the light most favorable to the non-movant. In other words, the court will draw all reasonable inferences in the non-movant’s favor. If the evidence, when viewed as favorably as possible to the non-movant, reveals the fact finder (usually the jury) would essentially have no choice but to rule in the movant’s favor, the trial is unnecessary and the court will enter a summary judgment in the movant’s favor on one or more of claims and defenses at issue. Even if some claims survive summary judgment, the summary judgment process can help narrow the scope of the dispute at trial and thereby save time and costs.

No cannabis business wants to be in litigation; at best it is an expensive distraction and at worst it can destroy a business. Motions to dismiss and motions for summary judgment can be good tools for trying to end the litigation early. In my next post, I will talk about alternative dispute resolution (“ADR”) and why it so often makes sense for cannabis businesses