We have been working on a number of marijuana license acquisition deals for the past several weeks that have been held up by existing claims against the seller. Claims against a business are notoriously difficult to value as compared to other liabilities like contract debt, utilities, or employee commissions. This is particularly true of marijuana businesses where parties are reluctant to air their laundry in court and where there has been a dearth of court decisions relating to marijuana businesses.
Just by way of example, let’s say that you had a falling out with a business associate at the outset of starting your marijuana business two years ago. You didn’t think you owed anything to each other, and you are getting ready to sell the business that you built over the last two years after your business associate left. Now just suppose that you are about to sell your business and your old business associate comes out of the woodwork demanding “her share” of the purchase price. She claims that she was a fifty-fifty owner and should get half of any sale money. How do you value her claim in the deal?
Marijuana businesses are at special risk for these types of occurrences because so many of them have historically relied on oral contracts and self-help enforcement rather than on detailed written contracts and the court system. Since hardly anyone would have sued two years ago for ownership in a marijuana business, claims like that were worth very little back then. Now, however, with increasing legalization, these sorts of claims can be valuable enough so as to require a real valuation before concluding a business purchase and sale transaction.
The first step is the most difficult: assigning a dollar value to the claim. Though litigation outcomes are inherently unpredictable, it is easy to predict that almost all litigation is expensive. Just about everyone loves discounting the claims their former business associates have to partial ownership, but those claims are often viable. Even the Winklevii got $65 million out of a business deal that evaporated before anything materialized.
In theory, valuing litigation claims can be stated simply. It is the claimant’s sought value multiplied by the chances of the claimant getting that value awarded by a court. If I sue Facebook for $1 million, but I have a 0.00000001% chance of winning that claim, I have a case worth one cent. The problem is that nobody has enough information or predictive ability to be able to accurately value the amount of damages one will get from a judge or a jury or the likelihood of that person or company getting anything at all.
This is why in doing business deals, we transactional lawyers try to find ways to avoid having to calculate the value of outstanding claims. This is typically done either by fast-tracking a decision on the claim or clearly shifting the burden of paying on any claims so that there is no longer any need to value them.
To put a decision on the fast track, we sometimes file declaratory judgment actions. In a “dec action” a potential defendant brings a case that the claimant would otherwise bring, and asks the judge to rule that claimant has no real claim. It’s risky because losing a dec action puts the party against whom a claim is sought at a serious disadvantage. If that party wins the dec action, though, the claim evaporates and is no longer a concern. More importantly, dec actions are seldom allowed for most types of claims so usually some other option must be pursued.
The other, far more common option, is to shift the burden of the outstanding claims so clearly to the seller that the claim need not be calculated into the value of the deal. If the seller sufficiently indemnifies the buyer from any potential claims against the sold business or property, then the transaction can take just the value of the property into account and can ignore any risks of future unknowable claims. But this only works if the buyer believes the seller has the financial wherewithal (or the insurance) to be able to pay on any claims against which the seller has provided indemnification.
If you are looking to sell your marijuana business, be prepared for your potential buyers to conduct their due diligence and for your past to come back to haunt you. You should also be prepared to deal with that situation when it comes up.