Commercial Cannabis Case Law Update: Federal Courts Continue to Find a Balance

We’ve written previously about how courts, especially U.S. District Courts charged with applying and interpreting federal law, are wrestling with inconsistencies between state and federal law when it comes to state-legal cannabis. A little over a year ago, the emerging solution when it comes to enforceability of contracts involving cannabis was to apply the legal principle that “even where contracts concern illegal objects, where it is possible for a court to enforce a contract in a way that does not require illegal conduct, the court is not barred from according such relief.” Mann v. Gullickson (N.D. Cal. 2016). Fast forward to today, almost a year after California’s new cannabis regulations have been percolating into the world’s fifth largest economy, and that permissive, mostly hands-off approach to state cannabis contracts seems to have not only solidified, but appears to have been applied in other states that have recently legalized cannabis.

In an Oregon case, the plaintiff sought to recover economic damages in a personal injury case stemming the future earnings of a cannabis company. The defendant argued that because cannabis is federally illegal, the court cannot award future earnings from what amounts to an illegal business. In denying the defendant’s motion for summary judgment, the court found that “Marijuana’s legal status is unique. It is neither fully legal nor illegal. Because [plaintiff’s] family cannabis business is allegedly legal under Washington law, I conclude that . . . Plaintiff may recover economic damages based on projected profits from that business.” Tarr v. USF Reddaway, Inc. (D. Or. 2018). In so doing, the court also favorably cited a 2017 Oregon federal case holding that an employee of a marijuana testing laboratory could bring a claim under the federal Fair Labor Standards Act despite the federal illegality of marijuana. Id., citing Greenwood v. Green Leaf Lab LLC (D. Or. 2017). Key to both decisions was that in order to grant the requested remedies (allowance of future economic damages for personal injury; allowing a claim to proceed for violation of labor standards), the court did not need to order either party to directly violate the federal controlled substances laws that otherwise prohibit cannabis. Rather, the remedies were ancillary to the fact that the parties happened to be engaged in cannabis business activity.

In Nevada, a state that legalized cannabis in 2016, a plaintiff wanted to enforce certain promissory notes against a cannabis cultivation business. Some terms of the notes required defendants to use the loan money to pay off debtors and purchase certain real estate in Nevada—both things the court found to be lawful objects of a contract. Other terms of the notes, however, required the defendants to use some of the funds as operating capital in their cannabis business, and to grant the plaintiff a right of first refusal to purchase part of defendants’ business, both things the court found to be unenforceable because they would require defendants to violate federal law. The court, citing favorably to the Mann principle, found in favor of the plaintiff and denied the motion to dismiss, and noted that Nevada law allows courts to interpret contracts so as to sever unlawful or unenforceable provisions while retaining and enforcing the lawful parts. Bart Street III, Inc. v. ACC Enterprises, LLC, et al. (D. Nev. 2018). The significance of Bart Street is that the court expanded the use of the Mann decision, which merely dealt with nonpayment of promissory notes, and narrowly interpreted cannabis contracts so as to allow plaintiff to proceed in its suit to enforce the lawful terms, even where other terms clearly violated federal law and the contracts as a whole involved a federally illegal business purpose.

Finally, in a Texas case applying the law of Illinois, a state that recently legalized medicinal cannabis, a plaintiff sought payment for certain promissory notes involving cannabis businesses, similar to the situations in Mann and Bart Street. The defendant raised the defense of illegality of the contracts as justification for not performing. The court, collecting cases from all over the country in support, found that the defense of illegality under federal contract law was more equitable than remedial, and more presumptive than absolute, instead requiring a balancing of factors such as “the avoidance of windfalls or forfeitures, deterrence of illegal conduct, and relative moral culpability.” Ginsburg v. ICC Holdings, LLC (N.D. Tex. 2017). The court also noted the importance of “creating stability in contract relations and preserving reasonable expectations” as counterbalances to the “costs in forgoing the additional deterrence of behavior forbidden by the statute” that renders the contract illegal. The court concluded that the defendant had not met the standard for a motion to dismiss if its sole argument was for illegality of purpose in the contracts. Ginsberg is remarkable in that the court continued the whittling down of federal law as an invalidating presence upon state contracts involving state-legal cannabis activity, and did so in a way that frames the decision as a culmination of established principles of contract law.

It remains to be seen what will become of the absolute federal illegality in cannabis, but in the meantime, federal courts continue to find ways around invalidating contracts simply because they happen to involve cannabis, and sometimes even when they include terms that require parties to violate federal law, so long as those provisions are severable.