Washington Court of Appeals Overturns LCB Interpretation of “Tied House” Rule

22 Jun Washington Court of Appeals Overturns LCB Interpretation of “Tied House” Rule

The State of Washington strictly regulates the relationships between marijuana producers and processors, on the one hand, and marijuana retailers, on the other. Many states permit the same persons to hold financial interests in all three types of licenses. But not Washington. Under RCW 69.50.328, neither a licensed marijuana producer nor a licensed marijuana processor may have a direct or indirect financial interest in a licensed marijuana retailer. This means that vertical integration from production to retail is prohibited in Washington, though it is common in Oregon and other jurisdictions.

This statutory prohibition on cross-tier financial interests led the Liquor Control Board (“LCB”) to adopt a regulation commonly known as the “tied house” regulation.  The tied house regulation provides that “No industry member or licensee shall enter into any agreement which causes undue influence over another licensee or industry member.” WAC 314-55.018.  Expressly exempted from the category of “undue influence” are agreements about the placing and accepting of orders for the purchase and delivery of marijuana made in accordance with usual and common business practice, and which are otherwise lawful. But exactly what the tied house regulation means in a practical day-to-day sense has been unclear.

In a recent opinion, the Washington Court of Appeals was called to interpret the meaning of “undue influence” in the tied house regulation as it relates to a dispute between members in a limited liability company that held a marijuana retail license. Yaron v. Conley, No. 80120-1-I (June 7, 2021).

The Facts of Yaron v. Conley

Like many cannabis business dealings, the facts involve individuals with holdings in multiple entities, which in turn have overlapping relationships and dealings.  In April 2014, the LCB granted the defendant Conley, in the name of her business, Mary Jane, a retail marijuana license for operation in Kirkland, Washington. In 2015, Conley approached the AVH & BJ Holdings LLC, which owned commercial property in Kirkland. The owners of AVH & BJ were Joseph, Bracha, the Plaintiff Yaron, and a company Auroraview Holdings, whose majority owner was Yaron. AVH & BJ was managed by Joseph and Yaron.

AVH & BJ leased the entire property to a separate company, JRM, which Joseph owned. JRM then subleased a portion of the property to Dynamic Harvest, a marijuana producer. Meanwhile, Conley struck a deal with Yaron, Joseph, and Bracha in which they would find commercial space for Conley’s marijuana business on the condition that they became her business partners and were named as part owners in the Mary Jane retail license. Later, Brancha abandoned the idea, leaving Conley, Yaron, and Joseph as the putative members of Mary Jane.

Yaron and Joseph submitted a Change in Governing Persons application to the LCB. They did not disclose to the LCB their interests in JRM or AVH & BJ Holdings. But the LCB later learned that Joseph, the owner of JRM, leased property to Dynamic Holdings, a producer. The LCB concluded that Joseph could not become a retail licensee without violating the tied house regulation and corresponding statute.

The LCB also began investigating Yaron’s ownership interest in Mary Jane. In February 2017, the LCB sent a letter stating that Yaron was prohibited from holding an ownership interest in Mary Jane because of his ownership interest in Auroraview. (Recall that Auroraview owned an interest in AVH & BJ Holdings, which company owned the property and leased it to JRM, who then subleased a portion to Dynamic Holdings.) This relationship, believed the LCB, violated the tied house regulation.

The LCB gave Mary Jane 45 days to remedy Yaron’s alleged violation of the tied house regulation or to eliminate his interest either in Mary Jane or Auroraview. Yaron began divesting from Auroraview but Conley moved to remove Yaron as a member of Mary Jane.

Yaron sued Conley for breach of contract, breach of fiduciary duty, and declaratory and injunctive relief. In her answer, Conley asserted, as an affirmative defense, that the operating agreement was illegal because it violated public policy.

After a bench trial, the trial court ruled against Yaron and in favor of Conley. The trial court concluded that Yaron’s ownership interest (through AVH & BJ) in a property leased by JRM to a marijuana producer (Dynamic Holdings) while simultaneously owning an interest in a marijuana retailer (Mary Jane) was a “regulatory cross-tier violation” because of the “possibility of undue influence exerted over either entity.”

The Tied House Regulation

Yaron appealed, arguing that the trial court erred when it concluded his ownership interests in ABV & BJ and Mary Jane violated the tied house regulation.

Here again is the text of the rule: “No industry member or licensee shall enter into any agreement which causes undue influence over another licensee or industry member.” WAC 314-55.018.

The Washington Court of Appeals agreed and reversed the trial court.  Among other things, the appellate court noted that the regulations do not define “undue influence.” The Court found the term ambiguous because:

Undue influence could apply to varying degrees of financial relationships. For example, it could apply to any landlord that has an interest in marijuana production, processing, or retail business and rents to a differently tiered marijuana business, even if the rental is not for its marijuana business. On the other side of the spectrum, it could apply to no landlords at all. Thus, the regulation is ambiguous with regard to what constitutes undue influence over another industry member in this situation and generally. But the statute provides clarity in that it applies specifically to licensed marijuana producers and processors and thereby points to a more narrow interpretation.

Here, reasoned the Court, Yaron was neither a licensed marijuana producer nor a licensed marijuana processor. Rather, Yaron was a manager of AVH & BH and under the lease between that company and JRM, his consent was required before JRM could sublease any of the property. So Yaron’s consent was required for JRM to sublease the property to Dynamic Holdings. But nothing gave Yaron control over the operations or the rent of Dynamic Holdings. His control was limited to the approval of the lease, which he signed before he gained an ownership interest in Mary Jane. (One wonders if the result would be the same if he gave his consent after he gained the ownership interest in Mary Jane.)

So although Yaron was subject to the statute because of his interest in Mary Jane, Yaron lacked sufficient ability to improperly influence Dynamic Harvest for the benefit of Mary Jane, or vice versa. The relationship, ruled the Court, was “too tenuous to result in undue influence” and his ownership interests did not violate the tied house regulation.

Takeaways

I find three important takeaways in this case. The first is that LCB is not always right in its interpretation of the statutes and regulations governing marijuana. (Neither is its Oregon counterpart, the OLCC, for that matter.) The second is that an LCB’s interpretation of a regulation, unless it is an adopted a policy position, is not entitled to deference. Here, the Court ruled that the LCB’s letters to Conley and Yaron expressing its interpretation of the tied house regulation were not entitled to deference because they did not contain agency policy. The third is that Washington licensees and putative licensees should consider carefully how to structure business relationships and transactions to avoid running afoul of the tied house rule. It is not clear cut as Yaron v. Conley demonstrates, so there are opportunities for the careful business owner and risks for the careless.