By: Gregory G. Lutje, Partner- Samuels Yoelin Kantor LLP
In November 1998, Oregon voters approved Ballot Measure 67, which allowed the medical use of marijuana within specified limits. The following year the Oregon Medical Marijuana Program was created to administer the registration program. As a result, there are currently approximately 230 medical marijuana dispensaries approved (by the Oregon Health Authority) for operation in Oregon. The Oregon legislature allowed cities and counties to place a one year moratorium on the operation of dispensaries within their jurisdictions, which moratorium expired on May 1, 2015.
Last November Oregon voters approved Measure 91, which legalized the recreational use of marijuana within limits. Beginning July 1, 2015, adults can grow plants and possess usable marijuana in their homes and on their person, but it cannot yet be sold, smoked or otherwise used in public. The Oregon Liquor Control Commission (OLCC) is required to begin accepting licensing applications by January 4, 2016 for commercial growers, processors, wholesalers and retailers.
Each day’s news cycle seems to include coverage and opinions as to how the Oregon legislature, OLCC (and even our congressional representatives and senators) are or should be dealing with reconciling the complex issues surrounding the medical and recreational use and distribution of marijuana. Meanwhile, demand for growing, processing and retail space by this nascent industry is burgeoning, as the brokerage community can attest. While anecdotal reports of double or triple market rate rents abound, prospective (and current) landlords should be aware of the risks they face when evaluating whether to allow their property to be used for such purposes. This article attempts to highlight such risks and identify some lease areas that warrant special consideration.
Federal Law- the 900 Pound Gorilla
Looming over all state and local laws, rules and regulations that permit, regulate and tax medical and recreational marijuana is the fact that they are all “trumped by” or subordinate to several federal laws that unequivocally make it illegal to use, cultivate, transport, sell or possess marijuana for any purpose. Most significant among the federal laws is the Controlled Substance Act (CSA), enacted in 1970. Landlords must be aware that the under the CSA it is “unlawful” to “knowingly … lease or rent” any place for the purpose of manufacturing, distributing or using any controlled substance, either as an owner or mortgagee, or to knowingly and intentionally rent, lease, profit from or make available for use, such a place. Criminal sanctions for violation of the CSA range from fines up to $2,000,000 and jail terms up to 10 years. Other federal laws provide for the civil forfeiture of real property associated with illegal drug activity.
Even though the current administration has issued executive-level guidance that its enforcement priorities will focus upon CSA violations involving minors, cartels and violence, the Department of Justice expects state and local governments that sanction marijuana to develop comprehensive regulatory and enforcement mechanisms, and warns that “[i]f state enforcement efforts are not sufficiently robust to protect against the harms … the federal government may seek to challenge the regulatory structure itself….” In sum, the current “truce” at the federal level is conditional and subject to change or revocation by the current or future administration.
Moreover, such a “truce” is not uniform, as evidenced by a recent bankruptcy case out of Colorado (where marijuana is legal) in which a creditor’s motion to dismiss the Chapter 11 case of a debtor that owned a warehouse used partially by a tenant for a growing facility was sustained. There the court held that it could not permit the landlord to “utilize the shelter of the Bankruptcy Code while continuing the unlawful practice of leasing space to businesses acting in violation of the CSA even though in compliance with state law”.
Mortgage and Financing Risks
As noted above, federal law puts mortgagees (lenders) at risk if loan collateral is used in violation of the CSA (and other laws). A 2012 Connecticut case held that a mortgage interest in seized property used to grow medicinal marijuana is inferior to the government’s forfeiture rights. Although some federal statutes provide lenders/owners with “innocent” lender/owner defenses, they apply only if the lender or owner neither consented to nor was aware of the criminal conduct and, upon becoming aware of the conduct, took measures to cause it to cease. Consequently, property owners of mortgaged property must be aware of the risk that their lender likely will issue a default notice upon becoming aware of the collateral being used for marijuana-related purposes. Most, if not all, loan documents contain a “compliance with laws” covenant prohibiting violations of federal, state and local laws and regulations. Landlords are advised to obtain competent legal review and analysis of loan documents to confirm applicable covenants and determine if notice and cure periods are required, or whether a lender can “accelerate” a loan without providing an opportunity to cure the default. Having a back-up plan to replace existing conventional loans with alternative private financing arrangements may be warranted as well.
Landlords are also well advised to seek competent legal (and insurance) advice regarding the susceptibility of both types of property insurance policies (casualty and liability) being invalidated because of the violation of use and compliance with laws covenants in such policies. A very recent federal appeals court case out of Michigan allowed a national insurer to escape fire damage coverage because the policyholder failed to notify the insurer that the basement had been converted to a medical marijuana grow house. Another recent California case involved a fire damage coverage dispute when the insured “directly or indirectly caused the loss or damage while engaged in committing or concealing a felony….”
Liability insurance coverage also may be similarly susceptible to challenges based upon violations of policy provisions. What if someone were injured in the course of a robbery at a marijuana warehouse or dispensary? While a landlord may be able to make alternative financing arrangements if its lender commences default/foreclosure proceedings, the loss of insurance coverage becomes known only after the loss/claim, and there is no fallback position.
Suggested Lease Provisions
As in much in of business (and life generally), a risk/reward analysis should be performed to evaluate whether or not to proceed with accepting the risk of leasing to marijuana growers/distributors in exchange for the reward of higher rents or occupancy levels. Assuming that a landlord has been informed of the risks outlined above and decides to proceed, what are some of the areas of a lease that should be specifically customized? The following are some suggested areas on which landlords should work with experienced legal counsel.
Permitted Use. Don’t be vague, e.g. “allowed to operate a lawful cannabis business.” Do be precise and list the allowed marijuana related activities—medical, retail, warehouse, growing, etc.
Compliance with Laws. Since compliance with federal laws is not possible, these lease provisions must require compliance with all applicable state and local laws, as well as federal laws not in conflict with the right to operate a marijuana business, such as the ADA.
Early Termination Rights. Landlords must be able to extract themselves from contractual obligations to tenants in the event issues arise with the government (federal, state and local), insurance carriers, lenders and others (such as other tenants or neighbors bringing nuisance claims). What if the landlord wants to sell the building but the purchaser does not want to assume the existing marijuana-related tenancy, or other tenants cannot obtain financing due to the existence of a marijuana business on the landlord’s property?
Lease Payments. Since no known financial institutions provide banking services to marijuana businesses (the one local Portland institution that had has now ceased doing so), it is exclusively a “cash” business, and payment and delivery protocols should be well thought out.
Tenant Improvements. Dispensaries and growing facilities require enhanced security, lighting, HVAC, utilities etc. Who pays for, owns and retains such improvements? Knowing the rules and expectations/requirements is essential.
Inspection Rights. Some states tightly regulate access to secure portions of marijuana-related premises, so landlords must be aware of potential limited access.
Common Areas. In multi-tenanted buildings, common areas such as parking lots may become a concern. Loitering, onsite consumption of marijuana, waste products, and ventilation are all factors to consider.
Indemnification. Landlords should be aware that standard lease indemnifications may not be adequate, such as when the indemnitor is judgment proof or a bad actor. Performance bonds or letters of credit may be appropriate substitutes or provide additional protection.
Oregon is only the third state to lawfully allow the recreational use of marijuana, and one of 23 to allow its use medically. While the use, possession, distribution and manufacture of marijuana remains in violation of federal law, landlords must proceed at their own peril and should take into full account the associated risks. Oregon lawyers are now allowed, under Oregon’s recently-revised Rules of Professional Conduct, to counsel and assist clients regarding Oregon’s marijuana-related laws and are required to advise clients of applicable federal laws. Prospective (and existing) landlords to the burgeoning marijuana business interests should seek competent legal counsel to assist with evaluating the risks, limiting exposure, and drafting appropriate lease provisions.