Marijuana Sales Contracts: Dealing With Price Fluctuations

Buying marijuana wholesale is not all that different from buying any other agricultural product and the sales agreement for such a transaction willtypically include price, quantity, and delivery times.

But as is true for other agricultural products, the parties to a marijuana sales contract should not expect marijuana pricing to remain static; as everyone in the industry knows, marijuana prices fluctuate. These price fluctuations mean that there can be price stability benefits for both sides in medium-term or long-term marijuana contract.

Marijuana retailers will be concerned about maintaining adequate inventory in states that are limiting total production, so it makes sense for them to seek out a long-term contract to guarantee they will have sufficient product to sell to their consumers.

But retailers who enter into such arrangements without sufficient protections will regret it if marijuana prices decline and supply catches up with or even exceeds demand. Retailers with long-term contracts at higher than market prices might find themselves priced out of the market or, at best, competing with other retailers that can pay significantly less for the same supply of product. On the other hand, if prices rise or supply dwindles, marijuana producers that have locked themselves into contracts with long-term (low) pricing will face similar problems.

These issues are only exacerbated when state-legal businesses are just beginning to operate. There will be too few licensed producers when retail shops first open their doors. Demand will be at an apex if only for the novelty of legal marijuana, but supply will be low. Producers will want to require long term contracts at existing prices and retailers will feel pressure to oblige.

Other agricultural products face similar situations when growing or harvesting first starts, or when weather impacts crop yields. But unlike marijuana, the markets for these products are more national (in many cases international), more liquid, more sophisticated, and more efficient. Buyers and sellers of other agricultural products are also usually able to at least somewhat hedge their price risks by buying or selling options on futures markets.

As marijuana legalization continues apace, I expect that we will see an actual commodities markets for marijuana emerge to help mitigate the impact of price fluctuations by using options, swaps, derivative trading, etc. But in the short term, large-scale marijuana buyers and sellers will need to employ the right contract terms to allow for flexibility and to mitigate risk. Just by way of an example, it’s not even required for a sales contract to specifically list out a price for it to be enforceable. The Uniform Commercial Code for the sale of goods has been enacted by all fifty states and it states that if a contract is silent on the price of an item or items, the price will be assumed to be “market price.” So, if your contract says that you will buy x number of pounds from your supplier every week, and yet makes no mention of price, the courts would impute the existing market price each week (or it the price can be based on the parties’ history of dealings, if any).

Things get more interesting when the contracting parties are willing to bet on price movements. If the retailer thinks prices will trend upward, while the producer thinks prices will trend downward, both parties should be willing to enter into a long-term contract at a fixed price, and by doing so, they would each be making a kind of bet on the pricing direction of the market, with each party bearing the risk of that bet. There is nothing inherently wrong with this model, but it is important for anyone who enters into such an agreement to know that they are gambling on pricing.

Bottom Line: The price provisions in long term contracts can either create or reduce risk. Use them accordingly.