This article will discuss the current California legal maze situation for opening a cannabis based business. If you are considering getting into the Marijuana / Cannabis industry feel free to contact us at firstname.lastname@example.org We assist your business venture from start to finish.
Since passage of the Medical Cannabis Regulation and Safety Act in California (“MCRSA”), our California marijuana business attorneys have been getting calls nearly non-stop regarding what folks can do now to have a medical marijuana business later in the Golden State. The passage of Proposition 64, California’s legalization initiative, has only accelerated the questions on what to expect in the future now that California will have a full-blown legal marijuana licensing system as well.
Though the three bills that make up the MCRSA and Proposition 64 lay the groundwork for California’s future medical and recreational marijuana licensing systems, these laws are only the beginning. California’s Bureau of Marijuana Control (“BMC”), and various other California state agencies granted governing authority under these new laws will be filling in the blanks on the actual substance of all medical and recreational rules and enforcement.
The below are the eight most relevant “blanks” when it comes to planning for having a California marijuana business in the future:
- Residency. The MCRSA doesn’t have an explicit or affirmative residency requirement yet, but that could change with future rule-making. However, Proposition 64 does. Chapter 5, Section 26054.1(a) of Proposition 64 states that, “[n]o licensing authority shall issue or renew a license to any person that cannot demonstrate continuous California residency from or before January 1, 2015. In the case of an applicant or licensee that is an entity, the entity shall not be considered a resident if any person controlling the entity cannot demonstrate continuous California residency from and before January 1, 2015.” This residency requirement will expire on December 31, 2019, unless the California state legislature renews it. Essentially, if licenses begin to issue in 2018, California legal marijuana has a three-year residency requirement. However, regarding a licensee entity, it’s the “controlling persons” that must be residents. Notably, “controlling” isn’t defined in the initiative, so the state will need to address this in its rule-making. How the state defines “controlling” will likely determine whether out-of-staters (including residents of foreign countries) can participate in California’s adult use marijuana industry as owners of a licensed business.
- For-profits. There’s been quite a bit of debate about whether the MCRSA will allow for-profit companies. In my view it will, and I base that on the law defining a license “applicant” as an “[o]wner or owners of a proposed facility, including all persons or entities having ownership interest other than a security interest, lien, or encumbrance on property that will be used by the facility,” and defining a “person” as “an individual, firm, partnership, joint venture, association, corporation, limited liability company, estate, trust, business trust, receiver, syndicate, or any other group or combination acting as a unit and includes the plural as well as the singular number.” Proposition 64 has almost identical language for the terms “applicant,” “owner,” and “person.” The big question is whether California will allow all existing non-profit medical marijuana collectives to just convert to for-profit companies (which is permissible under the California corporations code for non-profit mutual benefit corporations, which entities constitute the vast majority of existing medical marijuana operators), or whether it will instead force collectives to wind down before and start brand new for-profit companies. This transition matters for things like the distribution of assets upon dissolution, tax consequences, and the continued use of a non-profit’s already established goodwill. For more on our views regarding the California non-profit transition, go here.
- Financing. Both the recreational and the medical sides of California’s new laws are silent regarding financing, which means the state will have to address it through rule-making in the coming months. Beyond Proposition 64’s residency requirement for ownership and “control,” it is not yet clear who will be able to finance California marijuana businesses. In some states, residency requirements have forced licensees to rely on money from family and friends (see Washington). In other states, rule makers allow financiers from anywhere is allowed to invest in their local cannabis businesses. If California borrows from Washington, Colorado, or Alaska, financing for California cannabis businesses will likely be hamstrung by residency. If California takes its financing page from Nevada, Illinois, or Oregon (all of which have no residency requirements), cannabis investments in California will likely explode.
- Priority licensing. Both the MCRSA and Proposition 64 contain priority licensing thresholds. AB 266 of the MCRSA, at Article 4, Section 19321, states that “[i]n issuing licenses, the licensing authority shall prioritize any facility or entity that can demonstrate to the authority’s satisfaction that it was in operation and in good standing with the local jurisdiction by January 1, 2016.” Proposition 64 at Chapter 5, Section 26054.2(a) contains the following “priority” language similar to the MCRSA: “A licensing authority shall give priority in issuing licenses under this division to applicants that can demonstrate to the authority’s satisfaction that the applicant operated in compliance with the Compassionate Use Act and its implementing laws before September 1, 2016, or currently operates in compliance with [the MCRSA].” With respect to local law compliance, Proposition 64 provides that “[t]he [BMC] shall request that local jurisdictions identify for the bureau potential applicants for licensure based on the applicants’ prior operation in the local jurisdiction in compliance with state law, including the Compassionate Use Act and its implementing laws, and any applicable local laws.” None of this tells us much about what priority status will actually mean or the detailed standards for proving it. Does it mean you get to be first in line for a cannabis license? Does it mean you get a cannabis license and no one else does? It could mean a number of things depending on how the state defines it, which we likely will not know until the initial rules come out.
- Limitation on number of licenses. The MCRSA mandates that certain licenses be “limited” in number, but it doesn’t specify what those limitations will be. Limited licenses under the MCRSA include the “Manufacturing level 2” license “for manufacturing sites that produce medical cannabis products using volatile solvents,” the Type 3 outdoor cultivation license, the Type 3A indoor cultivation license, and the Type 3B mixed-light cultivation license. Other than prohibiting large scale cultivation for the first five years of the program, Proposition 64 contains no licensing limitations, though that could change once the state begins to rule make.
- Distribution. One of the hottest topics under the MCRSA is its mandatory distributorship. The MCRSA defines “distributor” as “a person licensed . . . to engage in the business of purchasing medical cannabis from a licensed cultivator, or medical cannabis products from a licensed manufacturer, for sale to a licensed dispensary.” Formerly, distributors were also the only channel through which cultivators and manufacturers could transport product to other manufacturers for further manufacturing, but this changed with the passage of SB 837 this year. Still, unlike any other cannabis legal state, cultivators and manufacturers must go through a licensed distributor to get their product to retail, and any additional roles and responsibilities of the distributor will likely come from the governing state agencies through rule-making. In contrast to MCRSA, while Proposition 64 requires use of a distributor by all licensees, a Proposition 64 distributor doesn’t have to be an independent company. And the only Proposition 64 licensees that will have to use independently owned distributors are large-scale cultivators with a Type 5 license, which licenses won’t even become available until 2023. Again, the exact role of the distributor under Proposition 64 will likely come via future rule-making.
- Licensing fees. Neither law tells us what the license fees will be. Given how other recreational states have behaved and that California wants to include its existing MMJ operators, it’s unlikely California will make its licensing competitive and cost prohibitive — though it may implement some sort of lottery system for the limited licenses under the MCRSA. In most recreational states, the license application fee has been $250 or less. In medical marijuana states however, license application fees have ranged from approximately $60,000 in Florida (non-refundable) down to $5,000 in Nevada. We know that under both the MCSRA and Proposition 64, license fees must be set on a “scaled basis” and calculated to cover the costs of administering the programs.
- What license applications will actually require. Neither law tells us what the state will ask for in its licensing applications. Even in less competitive cannabis licensing states the state regulators want to see every detail of your proposed cannabis business from start to finish. And in the more competitive states, the regulatory authorities usually want a full thesis-level explanation of every arm of your business. Based on the experience of our cannabis lawyers in helping our clients with cannabis licensing applications in more than a dozen states, you should, at minimum, expect California’s marijuana licensing applications to require the following:
- detailed financial and criminal background checks and disclosures for every owner and financier of the business,
- calculated start-up costs and annual budget,
- a detailed business plan and operational plan,
- a floor plan,
- proof of a lease agreement or right to use the proposed real property,
- buffer measurements,
- local law approval or compliance at some point,
- proof of security measures,
- proof of environmental compliance (or capability of compliance),
- proof of insurance,
- a transportation plan including a planned transportation manifest,
- list of products to be cultivated, manufactured, and/or sold,
- a list of soil amendments or fertilizers to be used on plants if you’re a cultivator,
- the type of closed loop system you’ll work in if you’re a manufacturer, and
- how products will be stored and quarantined if you’re a retailer.
For those looking on how California will interpret its “controlling” person requirement, Prop 64’s definition of an “applicant” provides some help. Proposition 64 defines an applicant to include the owner or owners of a proposed licensee, with “owner” meaning all persons with an aggregate ownership of 20% or more plus the power to direct the management of control of the licensee. For a publicly traded company, an “owner” includes the CEO, any board member, and persons or entities with aggregate ownership of 20% or more. For a nonprofit entity, an “owner” shall mean the CEO and any board members. If California decision makers decide to follow this interpretation to determine a “controlling” person for purposes of the residency requirement, it will likely capture out-of-state persons with at least 20% aggregate ownership and some sort of control over the entity. As of right now, if we had to predict, we would say that California likely will use these same rules to determine controlling persons for residency purposes as well.
It is also beneficial to compare California’s proposed residency requirement with those in other regulated medical and recreational marijuana states. Both Oregon and Colorado started out with a two-year residency requirement for all applicants, looking back from the date of filing. In contrast, Washington ended up with a six-month residency requirement for all license holders, managers, and interest holders, which captured practically everyone involved in the business. However, all three states have since amended their residency requirement with Oregon completely repealing its residency requirement for both medical and recreational businesses earlier this year. If the approach of these states serves as any indication, California may eventually take a less stringent approach to enforcing its residency requirement. The more states that allow out-of-staters to participate in their cannabis industries, the more other states will feel pressure to do the same.
A final challenge for out-of-state residents interested in entering California is that some California cities and counties have begun adopting their own local residency requirements. For example, a county may require an applicant for a local marijuana permit to demonstrate residency in the county for at least one year prior to the date of application. Taking it a step further, the City of Oakland’s draft cannabis ordinance included a provision that required half of all new permits go to residents of select neighborhoods with a history of higher marijuana-related arrest rates.
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