The Biggest Pitfalls of California Cannabis Leases in 2019

13 Aug The Biggest Pitfalls of California Cannabis Leases in 2019

We’ve written many times about how commercial leases to cannabis tenants are their own beasts. Generic leases don’t ever the job done. And, in California, as bad as some landlords want to rely solely on AIR and CAR forms, we generally caution landlords to have a customized lease arrangement when dealing with a cannabis tenant. And even though many of the provisions from the boilerplate will certainly make it into your custom cannabis lease, pretty much every provision has to be reviewed and reformed to cannabis-specific issues all with an eye to the state-federal law conflict. With that in mind, here are the biggest pitfalls for California cannabis leases in 2019:

1.     Local authorization.

So many proposed leases reviewed by our California cannabis attorneys completely miss the fact that before a tenant can secure a state license they must first secure local authorization from their city or county under the Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA”). The California cannabis scene is one of extreme local control, and all 482 cities and 58 counties are handling MAUCRSA differently, so landlords need to get very familiar with what cities and counties are allowing. I still get calls from landlords in unincorporated LA County that want to lease to cannabis tenants and the county still maintains a ban, which means there are no lawful cannabis tenants in LA County at this point. And in the City of L.A. many landlords are unaware of or confused about how Phase 3 licensing will work with social equity leading the way. Overall, landlords also need to understand that not all cities allow both medicinal and adult-use cannabis activity; it’s completely dependent on the city or county and will affect the lease accordingly. In turn, landlords should certainly require that their tenants seek out and secure local approval (and in almost all jurisdictions, the tenant will have to show specific landlord authorization to the local government) as part of their lease performance obligations. However, landlords must first really get a handle on what local authorization looks like in their own backyard to ensure that this specific tenant performance obligation actually makes sense under the lease.

2.     State licensing timeline.

With the advent of the legislature reviving and extending the lives of provisional licenses, it’s now pretty easy to get a state license (although local authorization is still required for that). However, a provisional license is not an annual license. Many commercial cannabis leases ignore the difference between provisional and annual licenses and mandate that their tenants just “secure a state license.” The timing of the state’s issuance between these two license types is wildly different though and it will make a difference for the lease at issue in that many landlords contemplate cancellation of their leases in the event state licensure of some kind isn’t secured by a set date. For annual licenses, it could be more than a year before a tenant gets one. For provisionals, it could be a matter of weeks depending on the agency in question. Nonetheless, the annual license is really the goal here that ultimately secures the licensee’s full ability to operate for a given year. In turn, landlords should be particular about the difference between their tenants getting provisional versus annual licenses relative to  the other performance and operational obligations during the term of the lease.

3.     Change in local and state laws and rules.

Since the state agencies began issuing licenses under MAUCRSA back in January of 2018, the state’s interpretation of its own rules has been unpredictable. Likewise, the cities and the counties (in charge of local authorization) have gone back and forth over whether they’ll regulate or ban cannabis, and for those that chose to regulate, they continue to reform their local laws as industry issues arise. Any given change in interpretation  by the state relative to agency regulation or any pivot by local government relative to local cannabis laws will undoubtedly affect a cannabis tenancy. For example, in Santa Barbara County, the County supervisors institute a cultivation canopy cap in July, which ultimately means that any would-be or existing cultivator in the County that was thinking about expansion or filing new applications for new cultivation sites that weren’t already in the permitting queue will be prohibited from moving forward regardless of whether they have an existing lease that allows for such actions. And if, for example, the California Department of Public Health (which oversees manufacturers) decides that certain products will be added to its prohibited products list, manufacturers must comply with such directive or they could face significant issues with their licenses. All of this to highlight the fact that a California cannabis lease must also contemplate almost constant changes to local and state laws and rules relative to actual cannabis operations.

4.     One licensee per premises. I

t’s been the case for some time now that California landed on the one licensee per premises rule. Nonetheless, landlords still seem to misinterpret this state law mandate on a number of levels. What the rule means is that a single licensee can only take up one “premises.” Think of the premises as the space in which the commercial cannabis activity takes place but not necessarily the entire property on which the premises sits. The easiest real-world example is a strip mall with multiple suites taken up by multiple tenants. In California, a cultivator could be housed in suite one with a manufacturer in suite two and this rule would be satisfied. Half the problem is that multiple cities and counties don’t really address this rule and we therefore see many leases that wrongfully allow multiple licenses of a single tenant to be housed in a single premises.

5.     Mortgage loan violations. 

California doesn’t have the toughest cannabis rules when compared to other states. As a result, we don’t have fantastic access to the financial institutions under the 2014 FinCEN guidelines, so it’s still pretty difficult for cannabis businesses to secure even just bank accounts. This means landlords will be paid in cash most of the time (or by a parallel management company that’s likely owned by or affiliated with the licensee so that the landlord can be paid with a check). Either way, once the landlord’s bank uncovers that it is leasing its property to a cannabis tenant (because its paid in cash one too many times or because the bank checks up on the collateral), mortgage violations abound. Why? Because this (usually) boilerplate document dictates that no waste or illegal activity take place on the collateral real property, and a cannabis tenant directly violates federal law and therefore the mortgage agreement between the landlord and its bank. This situation should be quarterbacked from the outset of the cannabis tenant and landlord relationship since it’s highly unlikely that the landlord will be able to successfully push back on the bank and will face losing the property to the bank as a result.

6.     Security, Insurance, and Access.

California like every other state has particular facility security and access requirements, and it also maintains particular insurance requirements for licensees. On security, what must be at the facility is determined by the agency issuing the license, and certain license types have more significant security requirements than others (for example, retailers need real live, state-qualified security guards during hours of operations while other licensees don’t). Landlords should at least be familiar with their tenant’s security installation requirements and also ask for a copy of the corresponding premises diagram to ensure that the tenant is adhering to these very specific rules. For access, not just anyone can enter a cannabis facility either, including a landlord (which will cut against the grain of most landlord friendly leases that allow free access with requisite notice). The tenant will basically need to have an ID badge for the landlord and “limited access areas” require accompaniment by the licensee at all times. All of this will need to be sorted in the lease to ensure that the tenant isn’t in default. And regarding insurance, only commercial general liability insurance is required for distributor licensees, but all licensees must secure surety bonds. Beyond that, insurance is to be negotiated between the landlord and tenant and it’s still no picnic in securing mostly traditional property and other kinds of insurance as a cannabis tenant (because of federal illegality).

Even in 2019, these lease pitfalls still exist in California. However, so long as landlords (and tenants) pay attention to the details of cannabis licensing and the accompanying state and local laws and regulations, an enforceable and solid cannabis commercial lease is entirely possible. For more on how (and why) to reform your existing California cannabis lease, see here.