The Top 5 Most Dangerous Cannabis Contracts in California

Obviously, work in the cannabis industry for attorneys is way more than just state license acquisition. In fact, after a few years and with the exception of competitive licensing regimes, state licensing slows down and is usually taken in-house by cannabis companies that formulate compliance teams. In turn, as time goes on, a significant amount of the legal work in the industry turns on transactions between licensees. California has certainly been no different (though we’re dragging in the licensing department, mostly because of local control issues). Still, existing licensees are having no trouble conducting transactions with each other and with third parties for goods and services as they race to gain market share and build their brands.

As California’s regulated cannabis industry continues to emerge, licensee transactions are becoming more sophisticated and diverse. At the same time, because of the newness of California’s regulated market (combined with regulators’ continuing evolution of regulatory interpretations), certain transactions are posing larger and riskier issues for licensees. This post is dedicated to the top five most dangerous licensee-to-licensee contracts in California:

1.      Slotting Fees.

In recent months, our California cannabis business attorneys have seen a good amount of “pay-to-stay” and slotting fee agreements between cannabis cultivators, manufacturers, distributors, and retailers for dedicated, prime-time shelf space. In commodities, especially saturated ones, face time with consumers isn’t great and margins can be really poor and the competition is vast. In California, only cannabis retailers can sell to the public, so it’s hugely important for wholesale and distributor licensees to have good placement on shelf space in dispensaries and on the retailers’ online menus. The slotting fee agreement essentially amounts to the lump sum fee the supplier pays to the retailer to reserve their sacred, strategic shelf space. The pay-to-stay agreement (which can be similar to the slotting fee) typically takes things a step further where it’s instituted after the initial slot and addresses issues for existing products like marketing, promotion, inventory stocking, failure fees, and paying extra to ensure that your competitors don’t get any valuable shelf space near you or at all. The question, though, is whether such agreements are kosher in California in the first place given that our state cannabis laws generally prohibit anti-competitive practices by licensees. The answer on validity under these laws is that “it depends.” Analyses around anti-competitiveness and slotting fee contracts is highly factually intensive, and California cannabis regulators don’t seem aware that this practice even exists. While these contracts can give great security to licensees, they can also be used to block and strangle out other wholesales that may not be as capitalized or strategic in the marketplace. For more on slotting fee agreements, see here.

2.     Distribution Agreements. 

Even though the Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA”) stripped distributors of massive amounts of power (since, unlike alcohol, cannabis distributors don’t have to take title to the products they distribute), they are still 100% necessary in the California cannabis marketplace because they are the only license type that can transport marijuana products and they’re also the only licensees that can coordinate the required third-party testing of licensees’ products. Plus, prior to any retail sale, licensees must ensure that a distributor undertakes quality assurance packaging and labeling reviews of their products, and they’re almost exclusively in charge of collection and remittance of the cultivation and excise taxes to the California Department of Tax and Fee Administration. Since wholesale licensees have to go through distributors to get to market, distribution agreements are necessary. If your distributors is just your freight middle man, these agreements are not that potent and risk-laden. However, if you’re using your distributor similar to an alcohol distributor (i.e., a brand house), you’ll need to ensure that your distribution agreement is way more aggressive regarding term, circumvention to retailers, purchase amounts, timing, acceptance and rejection of products, testing issues and recalls, regulatory compliance and accountability, and representations and warranties regarding the products at issue. Specifically in California, our cannabis business lawyers have seen far too many one-sided distribution agreements that aren’t properly drafted, aren’t compliant with MAUCRSA, and that pay no attention to detail.

3.     Real Property Leases. 

The reason why real property leases make the list is because all too often our California cannabis business attorneys have clients coming to them with boilerplate lease documents that don’t even mention MAUCRSA and/or the collateral effects and contingencies born by using real property for commercial cannabis activity. Real estate is one of the most important assets and must-have’s for all forms of licensure and permitting, so details around licensing timeline, code of conduct, federal intervention, commercial cannabis insurance, and local and state licensing compliance should be huge for the parties, and not some after-the-thought from a form lease document. For more on California cannabis leases, see here, here, and here.

4.     IP Licensing.

Intellectual property licensing in cannabis is already precarious where cannabis companies cannot secure federal protection for their trademarks from the USPTO.  More often than not though, cannabis companies can get trademark protection from the state governments in the states in which they operate. Of course, there can be additional oddities when it comes to state-specific IP protection for cannabis companies. In California, in particular, only cannabis licensees can register and protect their cannabis trademarks with the State of California.  And California was also about to have a very complicated relationship between third party, unlicensed companies that license their IP to cannabis companies, but backed off on second thought on adoption of the final rules in January of this year. The common case issues with cannabis IP licensing are whether the licensor even has the IP they say they do (and whether or not that IP is protected or even protectable, which oftentimes its not because of existing infringement problems) and the regulatory ins and outs applicable to IP licensing. In California, if you’re going to be an IP licensor to a cannabis licensee, you will need to be disclosed to the state as a “financial interest holder,” including if you’re taking a royalty as consideration for the granting of the license. Many operators  and their IP licensors fail to make this disclosure and/or don’t understand regulators’ position relative to this requirement, which makes performance obligations and regulatory accountability in the agreement even more opaque.

5.     Influencer Agreements.

Influencer agreements made the list because licensees typically forget or ignore that these contracts constitute advertising, marketing, and promotion, which is heavily controlled by MAUCRSA and the Bureau of Cannabis Control. Basically, as a licensee, if you use an influencer, you’re on the hook for their words and actions as they relate back to your company and products. All of this means that cannabis companies who want to work with influencers must use detailed contracts, training, and/or guidelines to educate their influencers on how to not violate applicable regulations. And this is not something that cannabis companies should gloss over in a two-page, boilerplate contract. Generic provisions that require all parties to follow all applicable legal requirements may be sufficient in some contexts, but influencers are probably not aware of the specifics in cannabis regulations, and in California, for example, you better make sure that your influencer is gearing their ads and promotions to adults only (and that they can prove that to a reasonable degree of certainty if regulators ask). In addition, the influencer pretty much can’t do anything that’s attractive to a kid (under the age of 21) and if they do, the licensee is going to be on the hook.

All of the above agreements need to be handled with significant care and a deep grasp of the regulatory landscape in California. As always, the boilerplate will not cut it when it comes to compliance and accuracy, so don’t get caught on the wrong side of one of these dangerous contracts.