Commercial leases for cannabis businesses are unique and require special considerationsfor risk management during the tenancy. Commercial cannabis leases in California are prone to the following pitfalls inherent in a landlord doing business with a cannabis tenant, and these risks should be considered when deciding how to structure your landlord-tenant relationship:
- Accepting ownership in the cannabis tenant company. Buying and selling shares in privately held cannabis companies can trigger state and federal securities laws and create regulatory problems under California’s cannabis licensing program. A landlord’s acceptance of an ownership share from a tenant in lieu of or in addition to rent can jeopardize the cannabis tenant’s California state cannabis license status. California’s proposed cannabis rules define an “owner” as a person with 20% or more ownership in the licensed cannabis company, a CEO or board member with 5% or more ownership in an entity with 20% or more ownership in the licensed entity, or any individual that exercises “direction, control, or management” of the licensed business. All such “owners” are subject to thorough background checks as part of the company’s ability to acquire and maintain its cannabis business license. A change in ownership or control puts the tenant’s license at risk of being revoked, harming both landlord and tenant.
- Receiving cannabis product as rent payment. Though cash-poor cannabis tenants may have trouble finding financing, they usually have plenty of valuable cannabis product. But for the same reasons landlords should avoid accepting ownership in their cannabis tenants business entities, they should also avoid accepting cannabis product as well. Not only does a tenant providing its landlord with cannabis jeopardize the tenant’s license (and thus the landlord’s source of rent revenue), it also exposes the landlord to liability for operating as an unlicensed cannabis merchant. California’s proposed cannabis rules strictly control who can and cannot handle or accept cannabis product as part of a licensed operation, and circumventing those strictures exposes both landlord and tenant to liability.
- Profit/revenue sharing. Commercial leases for garden-variety business tenants sometimes include terms requiring the cannabis tenant pay a certain percentage of its profits or revenue to its landlord in addition to or as part of rent. Though this sort of arrangement can be advantageous in other situations, it raises problems for cannabis tenancies since receipt of profits or revenue specifically tied to cannabis sales can expose the landlord to liability for unlicensed cannabis activity as a de facto owner.
- Liens for build-outs. Indoor agricultural grows require unique environmental control systems and this in turn often means cannabis tenants must engage in expensive build-outs. Landlords may want to seek lease provisions ensuring all alterations be authorized in writing beforehand, that the landlord acquires no ownership or benefit from any alterations, and that all alterations must be removed when the tenancy ends unless the landlord elects otherwise, in addition to serving notices of non-responsibility where appropriate. Essentially, landlords will want to avoid allowing build-outs that might result in liens filed against their real property. On the other hand, the landlord may want to be involved in the build-out to outfit the facility to its own preferences. In other words, landlords should seek to avoid unintended entanglements while structuring their leases to reflect their intent.
- Access and security. Though landlords typically want commercial cannabis leases to allow them access at any time with reasonable notice for things like maintenance, inspections, and showings, the situation is different for cannabis business tenants. California’s proposed cannabis rules under the Medical and Adult Use Cannabis Regulation and Safety Act (MAUCRSA) require cannabis tenants to set up and maintain a rigorous security protocol that only allows product to be handled by authorized individuals, and that only allows authorized individuals to access the premises. Unfettered access by a landlord will likely raise problems with California’s cannabis regulators, and with good reason. Part of the rationale for complying with strict state-mandated security requirements is to further federal enforcement goals, such as preventing diversion of product to minors or to states where cannabis has not been legalized. By failing to sufficiently regulate access in the lease, the landlord can unintentionally entangle itself with the operations of the licensed cannabis entity and thereby place its tenant’s cannabis license in jeopardy.
Bottom Line: California commercial cannabis tenancies benefit from being kept as arms-length transactions so as to protect against problematic entanglements, both intended and unintended and any proposed tenancy should be analyzed with this goal in mind.
Link – Canna Law Blog
