Hilary Bricken
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california cannabis violation

California cannabis regulators are slowly getting into enforcement mode under the Medicinal and Adult-Use Cannabis Regulation Act (“MAUCRSA”). Ostensibly, enforcement to date has been around illegal sales and/or around the manufacturing of illegal products (like vape cartridges). It’s only a matter of time though before enforcement becomes more sophisticated around licensing, including the state increasing scrutiny around “owners” and “financial interest holders”.

  • Owners are any person or company that owns 20% or more of the licensee or that exercises any management, direction, or control over the licensee (including board members, managers, and officers).
  • Financial interest holders are anyone or any company that owns 19% or less of the licensee or that invest in, lend to, or profit share with a licensee.

For whatever reason (but likely because of a lack of enforcement), many cannabis businesses in California don’t take very seriously the requirement to both accurately identify and timely disclose their owners and financial interest holders. And not all of that is their fault, as all three agencies in charge of California cannabis businesses essentially have different rules and interpretations around the disclosure process (though they should all be applying the same standards for owner and financial interest disclosures across the board).

According to the 2018 Bureau of Cannabis Control (“BCC”) disciplinary guidelines, failure to disclose a change in ownership is a tier 3 violation. Tier 3 violations are recommended for “Knowing or willfully violating laws or regulations pertaining to commercial cannabis activity; and Fraudulent acts relating to the licensee’s commercial cannabis business.”

Tier 3 violations also include the illegal sale of dangerous drugs or other controlled substances, so that category is reserved for the most serious rule violations. In addition, securing a license by fraud, deceit, or misrepresentation also constitutes a tier 3 violation. In my opinion, failure to disclose every single owner as required by MAUCRSA’s regulations can easily fall into a tier 3 violation depending on how egregious the business’s design is, if its intent is to hide certain owners or those in control of the business. The same potentially goes for financial interest holders that may be secretly funding or investing in a California cannabis business as far as I’m concerned. And, either way, under MAUCRSA, the state agencies have as much discretion as they want when deciding what penalties to apply for various violations; the disciplinary guidelines are just that–guidelines–and they’re not binding on the state.

The recommended penalties for a tier 3 violation are significant. At minimum, you’re facing a 45-day suspension or a fine according to a formula set by the state (some of which are staggering depending on license type), or some combination of both of those. At maximum, your license is getting revoked. Again, it’s up to the state to decide how they want to proceed, taking into account relevant mitigating factors depending on the violation at issue.

What I’m beginning to see now are a host of companies that never disclosed various owners or financial interest holders to the state. The state is now making the rounds on annual licensure, or because of changes of ownership, to really determine who the owners and financial interest holders are of a given licensee. Even more so, I’m seeing investors and owners just learning of these disclosure requirements and turning tail in the face of potentially invasive disclosures and background checks, or because they simply cannot comply with the disclosure requirements. For example, some of the investment funds in this space that have hundreds of participants typically have trouble when it comes to full disclosure of those individuals. Certain foreign investors also have immigration-related liability, or liability for cannabis investments in their home country.

Even if an investor or owner (which includes any director, manager, or officer) wants to bail on a cannabis company, if they were never disclosed their departure will not absolve the cannabis company of a major rule violation. Additionally, the investor or owner may face additional, personal liability for failing to adhere to state disclosure requirements depending on whatever shareholder agreement, operating agreement, investment agreement, or governance document they signed with the licensee. Typically, the foregoing agreements are all going to include representations and warranties and other covenants around knowledge of the regulatory process, accepting all requirements to maintain licensure in good standing, and cooperating with the licensee to ensure total compliance around licensing.

In the end, failing to disclose owners and financial interest holders can leave a cannabis business without a license and at the same time create significant personal liability for the owner or financial interest holder that doesn’t want to–or now cannot–disclose themselves to the state. As a result, all would-be owners and financial interest holders need to intimately understand the state’s disclosure requirements (and the timing around those requirements) and be prepared to perform accordingly. The alternative is to decide to stay in the ancillary space and spare themselves this step).

Any cannabis company still playing around with disclosure is going to find itself hurting when the state kicks into more robust enforcement around these owner and investment concepts.

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The Canna Law Blog™ is a forum for discussion about the practical aspects of cannabis law and how it impacts those involved in this growing industry. We will provide insight into how canna businesspeople can use the law to their advantage…

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