Oregon Cannabis: Beware the Services Agreement

15 Feb Oregon Cannabis: Beware the Services Agreement

Services agreements are a problem in the Oregon cannabis industry. These agreements have been around since at least 2016, when our office and at least one other law firm developed early templates in consultation with the Oregon Liquor and Cannabis Commission (“OLCC”). That form was called a “management agreement” and you will see them referred to in a variety of ways: services agreement, management agreement, transition agreement, management services agreement, etc. They are all similar and similarly problematic. In most cases, we now advise against their use.

What is a cannabis services agreement?

A cannabis services agreement can be defined in a couple of ways. A standard definition is: a “two-party agreement which provides for a non-licensee to operate or manage a licensee’s business.” Another definition could be: “a compliance and litigation hazard, often favored by unscrupulous or ill-advised parties.”

The term of a services agreement often commences upon the signing of a purchase and sale agreement for a licensed cannabis business (or its assets) and terminates when the sale closes. Some service agreements recite that periodic payments will be made by the licensee to the “contractor” or “consultant” throughout. These payments tend to be modest, but not always. We recently reviewed one where the seller agreed to pay the purchaser (a large, well known retail chain) the incredible sum of $100,000 per month to manage a store and farm– above and beyond the licensee’s standard payroll.

Large, frequent payments like those are not the norm in cannabis service agreements. In fact, many have mechanisms where payment is made only upon the sale closing. When it’s set up like that, the services agreement often provides that the contractor will receive a payment tied to the performance of the business over the services agreement period– in some cases, all of its net income. The idea is to retroactively jigger things as if the contractor had been an owner commencing on day one.

Finally, we also sometimes see services agreements outside of the sale context. This may be a situation where an owner wishes to hold onto the business, but hires a third party to run the business or make it profitable. On the contractor side, we have come across a few bad actors who repeatedly take over retail stores on this basis as a grift. These individuals will run a licensed business for a time, fail to pay everything from vendor invoices to Department of Revenue taxes, then move along once the jig is up. Litigation sometimes follows.

Cannabis services agreements are no longer a necessary evil

Services agreements became important features of sale transactions back when the OLCC was miserably behind in processing change-in-ownership transactions. Buyers were simply unwilling to wait six or eight months (sometimes more!) to begin operations while transactions languished in administrative purgatory. And it wasn’t just buyers driving the dynamic: sellers often wanted out quickly, too.

It was hard to fault the industry here– it’s not like people were trying to buy and sell casinos. These were little businesses and simple transactions, but the OLCC process had ground things to a halt. Suddenly, services agreements were everywhere.

This dynamic changed for the better at the end of 2020, when OLCC announced its streamlined licensing program. At that time, I wrote:

We anticipate a serious agency thrust to expedite change-in-ownership applications. The agency wants to get these “change orders” moving faster because of 1) the hardship caused to buyers and sellers arising from current months-long approval delays and 2) the fact that OLCC has been unable to process new license applications, given a) the never-ending stream of ownership change and license renewal applications, and b) the fact that OLCC is simply understaffed and underfunded for these circumstances.

The Commission did begin to move quickly on change-in-ownership applications over the next few months, and kept current. Processing dates for assignment of new applications have hovered between four and eight weeks for a long time now. Tack on another two to four weeks at the inspector phase, and applicants are generally getting licensed in roughly the amount of time you’d want to set aside under a normal purchase agreement to conduct due diligence. (Note: OLCC stopped updating its “current processing dates” website back in November. We hope they fix that, but last week the Commission again advised us that files are still running eight weeks out to assignment.)

Compliance problems with cannabis services agreements

We have witnessed an alarming number of compliance issues and outright litigation in the context of services agreements over the years. For sellers, the scary part is that once you’ve given over the keys, the compliance issues will accrue to your license, whether committed negligently or intentionally by the buyer running your business. Buyers had a free pass here, until OLCC changed its rules to allow license denial where the applicant “has, or previously had, an unapproved ownership interest in a license issued by the Commission…”. OAR 845-025-1115(2)(a)(J). That rule change was a direct response to this litigation.

In disputes arising out of services agreements, it is also common for one or even both parties to claim that the services agreement “did not reflect the true intention of the parties.” Usually, this is because the “true intention” was to affect a sale prior to OLCC approval. Other, common headaches arising from services agreements include:

1. Disagreements about reconciliation of amounts owed under the agreement, which are often held back in a related purchase agreement, inside or outside of escrow;
2. Disagreements about cash and inventory management on site;
3. Disagreements about employment, bill pay and vendor matters;
4. Disagreements about contractor activities, from accurate METRC reporting to paying state sales tax;
5. Insufficient protections for sellers arising from buyer-caused compliance issues; and
6. Services agreement terms being ignored or misunderstood, intentionally or otherwise, by one or both parties.

The bottom line on Oregon cannabis service agreements

In our experience, OLCC stopped asking to see transaction documents for ownership changes some time ago. Investigators stopped asking so many questions. Still, services agreements should be avoided whenever possible– especially by sellers. Enough can go wrong in a deal already; adding a services agreement will usually complicate things. These agreements also add needless license exposure at a time of relatively quick OLCC processing. Stay away.