Are CBD Contracts Legally Enforceable?

31 May Are CBD Contracts Legally Enforceable?

Many companies sign contracts to purchase industrial hemp or CBD extract for their business. But are these contracts actually enforceable under state and federal law? This question, and others like it, are becoming the focus of increased litigation as we experience an economic downturn in the overall hemp-related industry.

A fundamental principle upon which our entire business enterprise is based is that contracts between two or more legally responsible parties are enforceable – and will be enforced – by our courts. But an exception to this otherwise rock-solid principle has recently emerged from a hidden corner of the law: a contract that violates public policy may be deemed by a court to be void or voidable. Two recent state court cases and one federal bankruptcy highlight how courts view the enforcement issue and the conflict between these two titanic legal principles.

Legal Disputes

Miner’s Delight, LLC, in April of this year, opposed the Chapter 11 bankruptcy status of United Cannabis Corporation (“UCC”) and a subsidiary by filing a 47-page Motion to Dismiss this bankruptcy action in Colorado. Miner’s Delight strenuously asserted that UCC had engaged in illegal conduct that violated the Federal Food, Drug and Cosmetic Act (FDCA) by, among other things, making advertising claims with respect to its dietary supplements that can only be made for drug products. Miner’s Delight also charged and that UCC’s CBD isolate products violated the Exclusionary Provision of the Dietary Supplement Health and Education Act of 1994 and the FDCA. The exclusionary provision prohibits the use of a substance in a food product if that substance was first authorized for study in a drug trial. UCC’s response to the Motion to Dismiss is due on June 4.

Metsch v. Heinowitz was decided by a San Diego California Court of Appeals on April 22, 2020.  In its 30-page decision, that appellate court dealt with some knotty legal issues involving ownership interests pertaining to an unlicensed cannabis edible producer in the Golden State. A husband and wife, who alleged that they owned two-thirds of an edible cannabis company, sued a third owner and a consultant to the company for breach of contract, among other things. The trial court in San Diego granted the defendants’ Motion for Summary Judgment on the grounds that the contracts cited in the lawsuit were involved with a business that violated California state law with respect to the licensing of such a business. The appellate court affirmed that decision by declaring that “a party to an illegal contract cannot come into a court of law and ask to have his illegal objects carried out.”

“Since the doctrine of illegality of contracts is grounded in public policy, the focus is on whether the object of the contract is illegal, not on the extent of either party’s participation in the illegality. In applying the illegality of contract doctrine as a defense, courts do not consider whether its application results in unjust enrichment “secur[ing] justice” between the contracting parties, courts must consider “a higher interest — that of the public, whose welfare demands that certain transactions be discouraged.” Very simply, ‘a party to an illegal contract cannot come into a court of law and ask to have his illegal objects carried out.’”

In Rademacher v. Becker, a contract enforcement dispute was the focus of a 2015 Colorado appellate decision that did not involve either marijuana or industrial hemp. The dispute centered on a $300,000.00 promissory note, which the court ultimately refused to enforce on behalf of a domestic assault victim while assault charges were still pending against the defendant who had signed the promissory note. The defendant had thrown coffee over the plaintiff and kicked out the chair in which the plaintiff had been sitting. After $35,000 was disbursed, the defendant stopped paying and the victim sued to recover on the note. Why did the appellate court rule in favor of the defendant who reneged on his promise to pay the full amount owed to the assault victim? The Boulder County trial court refused to enforce the promissory note because the court decided it was against public policy to do so. This decision was rendered after the court learned that the defendant had agreed to the promissory note in exchange for the victim’s promise to advocate leniency for the defendant in the sentencing proceeding. The appellate court concurred with the trial court and said that the promissory note was geared toward influencing a witness in a criminal case action, which is clearly against Colorado public policy. Therefore, the court concluded it could not be a part of enforcing such a void agreement.

Advice for CBD and Hemp Companies

Lessons to be learned:

[1] State Law Knowledge.  Before a contract is executed, it’s imperative to fully understand the law of the state where a court is most likely to apply. If your contract becomes the subject of serious contentions and possible litigation, state law is a game-changer, especially in cannabis-related contracts, including those involving industrial hemp. For example, Colorado law expressly asserts that a contract entered into pursuant to the Colorado Marijuana Code is not void or voidable as against public policy. Although a federal statute, such as the Controlled Substances Act, could be deemed by some judges to pre-empt the Colorado statute, a heavy burden of persuasion will rest on your opponent. 

[2] A Contract Clause Inclusion. Businesses should consider including a contract clause such as the following:  “Each party agrees that it will never assert as a defense in any litigation or dispute resolution forum the position that this agreement is unenforceable, void or voidable because the subject of this contract involves, in any way, cannabis, marijuana, CBD or industrial hemp.” 

[3] A Contract Clause Exclusion. Reconsider the wisdom of always including in contracts the standard representation and warranty that each party shall comply with all state, federal, and local laws and regulations.  Keep in mind that such a rep/warranty also applies to you and your business.

Courts have a considerable amount of discretion regarding when to apply the “illegal contract” doctrine. The presumption is – and should be – that contracts are enforceable, but the hemp industry is treading in murky waters. The outcome of litigation will always be influenced strongly by the particular facts before the court. Advance attention to this topic may serve you well.

Jim Prochnow is a senior partner in the global law firm of Greenberg Traurig and is a former Department of Justice lawyer. He has specialized in food and dietary supplement law for decades and now has a focus on industrial hemp ingredients and products.

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