Cannabis Litigation: Attempt to Plead Around the “Illegality” Defense Fails

22 Jul Cannabis Litigation: Attempt to Plead Around the “Illegality” Defense Fails

As the country moves toward decriminalizing and even legalizing marijuana, federal courts largely remain closed to commercial disputes involving marijuana by operation of the illegality defense.  We’ve written about the defense on several occasions, see here and here. Briefly, the illegality defense is an affirmative defense pleaded by a defendant who has been sued for breach of contract or other related business torts. It applies in contexts other than marijuana to be sure but is often raised by a defendant who seeks to dismiss a federal court case on the ground that the contract is void because its subject matter is illegal under the Controlled Substances Act.

Increasingly the mere fact that marijuana is involved does not by itself preclude seeking relief in federal court. For example, the Tenth Circuit has ruled that the Fair Labor Standards Act applies to marijuana industry employers. Other federal courts have permitted cases to go forward where a contract may be enforced in such a way that does not condone or require illegal conduct such as requiring a cannabis company borrower to repay a loan it had received.

A recent ruling from the District of Colorado reflects that federal courts remain wary of civil disputes involving marijuana and will look past the surface allegations of a complaint in assessing the applicability of the illegality defense.

In Sensoria, LLC et al. v. Kaweske, et al. (D. Colo. No. 20-cv-00942-MEH), the plaintiffs sought to recover their investment in a cannabis business known as Clover Top Holdings and filed claims for breach of contract, civil theft, fraud, breach of fiduciary duty and so forth. In an early ruling the court dismissed most of the claims because of Clover Top Holdings direct involvement in the growing and selling of marijuana.  But the court allowed plaintiffs to replead claims because there was the “potential” that plaintiffs might be able to seek relief that did not implicate federal marijuana laws.

The plaintiffs repleaded their claims and attempted to avoid the illegality issue by reframing their relationship with Clover Top Holdings. The amended pleading cast their involvement in Clover Top as that of a passive investor whose intention was to invest in a lawful business. And although plaintiffs knew Clover Top was involved in cannabis, there were aspects of cannabis and hemp that do not violate federal law and so the investment could have been lawful. Defendants moved to dismiss.

The court noted that the intention to invest in a lawful business did not render the illegality issue moot and, consequently, reframing the relationship did not by itself preclude dismissal. Plaintiffs emphasized that certain Clover Top assets, such as land and buildings, are not inherently unlawful and argue to seek relief against those types of assets. But the court was not persuaded, reasoning that those assets were being used for marijuana and could be the subject of criminal forfeiture. So the court rejected plaintiffs attempt to recover those assets as a form of compensation. Ultimately the court concluded that marijuana “lies at the heart of the business and thus the lawsuit.” Accordingly, the court found itself unable to award any form of relief that would not implicate the federally unlawful activities of growing, processing, and selling marijuana.

Although an unfortunate ruling for the plaintiffs, they may try to continue their claims in state court where the illegality defense—at least in states where recreational marijuana is legal—is a nonstarter. Many cannabis businesses, especially larger multi-state operators, would prefer to litigate in federal court rather than state court for a variety of reasons. Unfortunately, until the federal government enacts legislation that would permit federal courts to enforce marijuana contracts like any other subject, cannabis business disputes will remain relegated to state courts. The Sensoria case shows that although some business disputes involving marijuana may be prosecuted in federal court, a plaintiff cannot rely on artful pleading alone to avoid the illegality defense.