Oregon Cannabis and Residency Requirements: It’s Complicated

Now that the OLCC rules have been out for a couple of weeks, we have had a long, hard look at Oregon’s two-year residency requirement as it relates to recreational marijuana licensees. That stricture applies to every license “applicant,” which is a term of art under the rules. Depending on where you sit, the residency requirement carries different implications. For some it is an important safeguard for Oregon operators; for others, it is a clumsy roadblock that capital must find its way around.

Ballot Measure 91 did not contain residency requirements, but they were added by the legislature and they are codified in HB 3400. That statute requires “an applicant listed on an application” to have been an Oregon resident for two years. See Sections 12(b), 14(b), 15(b), and 16(b) (producers, processors, wholesalers, and retailers). The OLCC was stuck with that in rule-making, despite an apparent change of heart by several members of the Joint Committee on Implementing Measure 91, who wrote last month to the OLCC that they wish to do away with residency requirements in 2016. “We now believe that broad residency requirements and significant limits on outside investment could do more harm than good,” the legislators said. Other key voices, like the Oregonian, agreed.

Oregon cannabis residency requirementsBecause of the last minute groundswell against residency requirements, the OLCC fashioned a rule that allows the commission to keep license applications by non-residents under review until 30 days after the 2016 session. OAR 845-025-115(1)(a). Though this was welcome news for out-of-state players (and their Oregon partners), it does not afford a clean point of entry for non-residents who wish to act as more than passive investors. To understand the specific contours of the residency requirement and how it affects these non-residents, one must dive deeply into the rules. And that takes some focus!

The rules generally distinguish “applicants” from those “who are not applicants but have a ‘financial interest’ in the business.” 845-025-1030(3). An “applicant” includes (1) any individual with a “financial interest” in the business for which licensure is sought that is also “directly involved in controlling the ordinary course of [] the business.” 845-025-1045(1)(a). It also includes any legal entity with a “financial interest” in the proposed licensed business that is also “directly involved in controlling the ordinary course of [] the business.” 845-025-1045(1)(b). The rules clarify that an individual or legal entity will not be considered to be “directly involved in the ordinary course of business” solely by (a) being a member of the entity, (b) being an employee or independent contractor, or (c) participating in matters that are not in the ordinary course of business. 845-025-1045(5).

The term “financial interest” is broadly defined as “having an interest in the business such that the performance of the business causes, or is capable of causing, an individual or a legal entity with which the individual is affiliated, to benefit or suffer financially.” 845-025-1015(15). This includes, but is not limited to, (a) receiving, as an employee or agent, out-of-the-ordinary compensation, (b) lending money, real property or personal property to an applicant or licensee for use in the business at a commercially unreasonable rate, (c) giving money, real property or personal property to an applicant or licensee for use in the business, or (d) being the spouse or domestic partner of an applicant or licensee. 845-025-1015.

Read together, these rules appear to safeguard passive investors, who would not be considered applicants so long as they have limited involvement in the business. At first blush, the rules also seem to indicate that an individual who merely owns shares or a membership interest in a corporation or company, is not subject to the residency standard. Unfortunately, however, 845-025-1045(3) provides that if a legal entity is designated as an applicant, then all members of the legal entity must also be “listed as an applicant” (and strangely, there is no mention of shareholders here, just directors and principal officers of a corporate entity, LLC members, and partnership partners). Moreover, 845-025-1045(10) requires that “an individual listed as an applicant on an initial or renewal application, or identified by the commission as an applicant must maintain Oregon residency while the business is licensed.” This rule appears to require that all members of a limited liability company, and all directors and principal officers of a corporation, be Oregon residents. Could this be what the OLCC intended?

Note that 845-025-1045(3) and 845-025-1045(10), read together, appear misfit with 845-025-1045(5). For example, an LLC member who is “not directly involved” in the business and therefore not an “applicant” under 845-025-1045(1), nonetheless becomes a “applicant” by virtue of LLC ownership (without direct involvement) under 845-025-1045(3). This result may be due to the OLCC’s efforts to distinguish between “legitimate owners” and other owners for purposes of the HB 3400 residency requirements. It’s not clear.

In any case, the rules provide that at least one applicant or the sum of applicants listed on an application must be a “legitimate owner” of the licensed business. 845-025-1045(4). An individual applicant or applicant legal entity will be considered a “legitimate owner” if (a) the individual applicant or legal entity applicant owns at least 51% of the business proposed to be licensed, or (b) one or more individual applicants or applicant legal entities in sum own at least 51% of the business proposed to be licensed. 845-025-1045(6). Ownership means “direct or indirect ownership of the…membership interests, or other ownership interests of the business proposed to be licensed.” 845-025-1045(8).

For non-residents and would-be investors, it is critical to note that the following factors, on their own, do not constitute ownership: (a) preferential rights to distributions based on return of capital contributions, (b) options to purchase an ownership interest that may be exercised in the future, (c) convertible promissory notes, or (d) security interests in an ownership interest. 845-025-1045(7). Many non-residents will use these vehicles to take contingent interests in a licensed business. Those interests would be exercisable in 2020, when the residency requirements sunset, or earlier if the legislature addresses these issues. Hopefully, that happens in the next session.

For now, the OLCC advises us that due to a myriad of questions they have received on the “applicant” and residency issues, they will be publishing examples of specific scenarios with applicant entities involving nonresidents. That should happen next week at the latest. The OLCC also advises that we should see the form of applications in early December. Finally, potential licensees should be encouraged to know that every application will be assigned to an OLCC investigator, who will work with the application’s point of contact on certain issues that could trigger an application denial. This would include residency issues.