280E and Recreational Cannabis: It Keeps Coming Back to This

As California nears a ballot vote on legalizing recreational cannabis, the Ninth Circuit has ruled on the very important issue of whether cannabis businesses may deduct their business expenses. While the case, Olive v. Comm’r, dealt specifically with a medical cannabis business, it has far-reaching implications for future cannabis businesses (regardless of whether they’re medical or recreational). Deductions allowed for business expenses are the keystone tax benefits and incentives for taxpayers to run their own businesses. Without these deductions, running and owning a business becomes an even more cumbersome and costly endeavor. This, in turn, diminishes incentive for current black-market participants to enter the legal sphere. (See my previous post for a discussion on why these consequences should matter to all Californians, proponents and opponents of legalization alike).

On July 9, 2015, the Ninth Circuit affirmed a previous Tax Court decision denying a medical cannabis dispensary the typical tax deductions afforded for ordinary and necessary business expenses. Petitioner, herein referred to as Taxpayer, owned a medical marijuana dispensary and was denied deductions for his business expenses because his particular business fell under one very consequential exception of the Federal Tax Code: section 280E. Despite months of speculation as to whether Section 280E applies to cannabis businesses, it is now clear that it does apply to medical cannabis businesses, and, based on the rationale of the Court, will apply to recreational cannabis businesses as well.

For those unfamiliar with section 280E, it specifically prohibits deductions for business expenses incurred where the  “trade or business” consists of trafficking controlled substances prohibited by federal law. The Controlled Substances Act classifies cannabis as such a substance and federally prohibits its use or sale. Marijuana businesses are required, like all other businesses, legal or illegal, to adhere to both state and federal tax laws. 280E changes liability substantially: cannabis businesses have to capitalize the cost of the business expenses and have to wait until the product is off the shelves to report the “Cost of Goods Sold” (COGS). The items that constitute COGS are much more limited than the plethora of expense types typically allowed under the business expense deduction. COGS, for example, include the cost of purchasing inventory (or product such as cannabis flower), and storage. In contrast, the business expense deduction includes rent, employee wages, and insurance, among others.

In Olive v. Comm’r, Taxpayer argued that 280E should not apply and he should be allowed to deduct his business expenses. His argument relied on recent federal directives (e.g., the Cole Memorandum, 2015 Appropriations Act (128 Stat. 2217), etc.), which cumulatively give states the latitude to implement legalized cannabis systems without federal interference. The Court disagreed and pointedly explained that the applicability of section 280E to cannabis businesses is wholly separate from recent federal directives regarding the enforceability of federal preemption of statewide legalized cannabis systems. The Court’s opinion rested on the statutory interpretation and authority within section 280E, and the meaning of “trade or business” as used in the tax code.

First, the Court opined that recent federal directives regarding cannabis do not preempt or reverse the current statutory law governing tax deductions for business expenses. The determination of whether section 280E applies to cannabis businesses is a matter of statutory interpretation of section 280E and the Controlled Substances Act (CSA). To date, Congress has not amended or repealed the CSA. Thus, the sale and use of cannabis remains prohibited by the CSA, i.e., federally prohibited. And, as mentioned above, section 280E specifically precludes deductions for businesses whose “trade or business” consists of activities that are federally prohibited. The language of both federal provisions is simple and easy to interpret. The Court found that the first prong, as to whether the “trade or business” was federally prohibited, applied, and therefore prohibited the taxpayer from deducting his business expenses.

Next, the Olive Court defined “trade or business,” saying an activity constitutes a “trade or business” where the activity was entered into with the dominant hope and intent of realizing a profit. 792 F.3d 1146 at 1149 (citing 477 U.S. 105) (emphasis added). The Court was clear that Taxpayer’s sale of medical cannabis was the only activity that met the “trade or business” standard as it was the only one that generated income. The Taxpayer’s business offered patrons other services including, but not limited to, yoga, counseling, and food and drink. However, all of those activities were offered free of charge to patrons. Thus, the Court concluded that the free services were clearly not offered with the dominant hope and intent of realizing a profit. In the Court’s view, Taxpayer’s only “trade or business” was the sale of medical cannabis.

The Court recognized that the taxpayer’s business was legal on the state level. However, federal law still controls where the issue being litigated deals with federal tax law. Despite federal directives that have eased or eliminated enforcement of the CSA, the law is still the law in this court’s eyes. And unlike other tax codes, section 280E uses clear and plain language. There is no other way for the Court to interpret such a statute. Unfortunately, recreational cannabis also clearly falls under the CSA prohibition and therefore to section 280E. Thus, the analysis used here will remain the same. Section 280E will continue to pose a costly problem for cannabis businesses.

Although the Ninth Circuit’s ruling is legally sound, it is a disappointing outcome for cannabis businesses held in the states comprising the circuit. It also sets a strong precedent for other circuits to follow. For California, however, this ruling comes at an opportune time as it and a number of its sister states prepare for the so-called inevitable legalization of recreational cannabis. Armed with the knowledge that 280E will apply to cannabis businesses, California can take a more proactive approach and establish a state tax model that considers the effects section 280E will have on its local businesses.

States embarking on legalizing recreational cannabis should recognize the 280E problem and realize that it will continue to cost cannabis businesses more than those in other industries. Implementing a new recreational cannabis system with high State taxes will win votes and may draw in high revenues initially, but such a system will only make it more challenging for small businesses and new business owners to remain profitable and open for business. High taxes also do not help educate users on safety or help diminish the social harms associated with cannabis use. (See “Cigarettes and Booze” for the full discussion on this topic). Lower taxes or incentive programs that include state tax credits for compliance, on the other hand, are great options to relieve recreational cannabis businesses from the cumbersome consequences of 280E. Incentive programs and State tax credits can also be especially useful for encouraging “best practices,” or compliance with regulations that are specifically designed to lower specific social harms. (See my earlier post for examples from the tobacco and alcohol industries). From a business and economic perspective, they could also lead to a more stable industry by allowing businesses to flourish and thereby remain in the legal market. Above all, such options incentivize market participants to enter the legal sphere, and will help small businesses grow within California.

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From the MMRSA to the Adult Use of Marijuana Act: the Distributor License

There are two adult use cannabis legalization initiatives – proposed laws – that had been gaining supporters over the past few months in preparation for the 2016 vote. First is the Adult Use of Marijuana Act, (AUMA) which boasts backing by Sean Parker[1], former president of Facebook and current Silicon Valley billionaire, and Lieutenant Governor Gavin Newsom. Second is The Control, Regulate and Tax Cannabis Act of 2016 (CRTCA), an initiative put forth by Reform CA, backed by co-proponents Dale Sky-Jones, chancellor of Oaksterdam University, and Alice Huffman, president of the California NAACP and board member for the national sector of the organization.

ReformCA has suspended its initiative. A majority of ReformCA’s board members endorsed the AUMA after its drafters amended their initiative to bridge the gaps between it and the ReformCA initiative[2]. One of the problematic differences[3] between the two is that the AUMA provides for a three-tier structure, adding a “distributor” license to reflect the recently enacted MMRSA[4] provisions. This article’s focus will be the AUMA’s adoption of the Medical Marijuana Regulation and Safety Act’s (MMRSA) three-tier system and the public policy considerations surrounding the decision to keep it, followed by policy recommendations aimed at (1) streamlining the supply chain, (2) keeping product quality high, and (3) ensuring a fair market throughout the supply chain[5], namely among the distributor class.

Where We’ve Been

On October 9th, 2015, the California legislature passed[6] and Governor Brown signed the MMRSA as written.

Instead of maintaining the status quo ante – cultivators (farmers) selling directly to retailers (dispensaries) – the MMRSA mandates that licensed manufacturers and cultivators send their product to a licensed “distributor,”[7] who then gets to collect a fee for, essentially, recording the harvest, production, or sale. Curiously, licenses for distributors (Type 11) are not the same as licenses for transporters (Type 12). Type 11 licensees are required to also become transporters; they “shall apply for a Type 12 license, but shall not apply for any other type of state license.”[8] Type 12 licensees “may” also apply to be distributors. That is confusing because Section 19326(a) of the B& P Code mandates that the only licensees who can transport cannabis are licensed transporters, which begs the question: what is the distributor for, then?

Subsection (b) attempts an answer: “All licensees holding cultivation or manufacturing licenses shall send all medical cannabis and medical cannabis products to a distributor . . . for quality assurance and inspection.” It also requires that those goods go to a Type 8 tester before sale to a dispensary[9]. Subsection (c)(1) explains that it also falls upon the distributor to “inspect the product to ensure the identity and quantity of the product” and make sure that a sample is tested for quality. Subsection (c)(2) explains that after a product has been tested for quality, it must go back to the distributor for a “quality assurance review,” to ensure “quantity and content” of the cannabis.

It is reasonable to assume that the MMRSA established a comprehensive regulatory structure – including creating a government agency[10] – that would also be the regulatory framework when it came time to legalize cannabis for adult use[11]. Thus, the MMRSA’s provisions would likely be translated into whatever bill legalized adult use. Indeed, the licensing section of the AUMA references Chapter 3.5 of Division 8 of the Business and Professions Code, which is the MMRSA. One of the main legalization pushes – in states that are looking to legalize adult use cannabis – advocates regulating cannabis like alcohol, which is already widely regulated at the state level. That policy is appealing from the state’s perspective because of the easy transition – states already regulate liquor sales. Further, it accomplishes the government’s financial objective: collecting taxes.

However, it puts strain on smaller firms either looking to break into or expand within the distribution market. The medical cannabis industry moves a lot of money, but clearly the adult population of the ninth biggest economy in the world is a more significant market than only the Californians that have prescriptions for medical cannabis. Established distributors in other markets – alcohol, for example – already have the infrastructure, technology, and capital to fill the distributor level in states that opt to regulate cannabis like alcohol. In concrete terms, this infrastructure includes inventory and accounting resources, which translates to lower level personnel (those whose job it would be to keep tabs on inventory), accounting staff (or an outside CPA on contract), and the technology that accompanies both of those positions.

The Argument for, and Problems With, the Type 11 License

The argument for inserting the distributor level is that the cannabis industry needs a “choke point” in order to limit supply. The government has two interests here: prevent diversion of (1) either cannabis itself, or (2) taxes that should have been paid on cannabis by failing to declare the correct amount harvested and sold. Those are legitimate objectives to be sure, but the means don’t justify the end – a small number of firms dictate supply for the whole market simply by virtue of their preexistence.

This hurts consumers in several key ways. First, prices will be higher: the distributors will be charging a fee, which either consumers or cultivators (or both) will have to absorb some or all of. Every time cannabis is harvested or “manufactured” (e.g., processed into edibles or concentrate), there is another fee, which gets passed down the supply chain. Second, quality will be lower. Liquor is distilled and therefore non-perishable, but cannabis is a crop that is better fresh – quality goes down the longer it sits. Third, selection will be slimmer. Large firms[12] will lack incentives to work with the mom-and-pop cultivators; it will be the same amount of work and fee collecting for a smaller product. There are huge barriers to entry for businesses that want to become distributors – established firms already have the necessary structure in place, dominate the market and will push out competitors because it means more profit for them.

It is worth clarifying that cultivators are not required to sell their product to distributors under the MMRSA, and they are allowed to keep direct relationships with retailers. However, they must still send their harvested or manufactured products to a distributor to insure identification, weight and content. Thus, the effect is the same – all of the fees and cannabis in the state go through the few companies that have readymade operations and therefore no interest in preserving the diverse, grassroots industry that cannabis has made itself into.

Policy Recommendations

There are two areas of public policy that deserve attention with regard to the Type 11 distribution license: (1) damage to consumers, and (2) waste – namely, of consumers’ money. The stated purpose of the distributor is to, first, ensure the identity and quantity and, second, ensure the quantity and content of cannabis or cannabis products. It seems that they will function as sort of a cannabis mailroom, where everything is sent, weighed and sorted both before and after testing. It is mysterious, then, why those three[13] aspects of a cannabis harvest (or manufacture) cannot be recorded by the cultivator, the tester or the transporter.

  1. Damage to Consumers

The Type 11 license hurts consumers in two significant ways, as mentioned above: pricing and selection. The resolutions to each of those negative effects on consumers chiefly hinge on the elimination of the Type 11 license. Taking that as the general thesis of this post, the analysis continues regarding alternate ways to resolve each of those issues.

Price Increase:

If the enacted regulatory scheme includes the Type 11 distributor license, then the price increase is unavoidable[14]. A distribution fee is the only method by which Type 11 licensees can make money. However, they are not making money for ‘distributing’ – they are making money for inventory management; i.e., recording the quantity cultivated or manufactured. The requirement that a Type 11 licensee apply for a Type 12 license abates this problem slightly: the cost of transporting cannabis – which, alone, a Type 11 licensee is disallowed from doing – is easily incorporated into normal costs that a Type 12 licensee would encounter: trucks, gasoline, and records of both transactions and travel, for example. Thus, the Type 11 and Type 12 licenses can, and should, be combined in the AUMA to avoid this extra charge being passed down to consumers.

Transporters can be charged with handling records of quantity and content, as could testers. Both will already be charging a fee, and however many people it was going to take to run a distribution company – here I am speaking to the notion that Type 11 licenses are an instrument of job-creation – will be employed by either of the licensee business types (8 or 12) that absorbs it.

Selection:

Distributors are charged with handling all of the cannabis in the state, which is a considerable load. Since distributors will have a full plate, some cultivators and manufacturers will be pushed to the fringe. Most likely, those will be cultivators and manufacturers with a smaller yield of cannabis or cannabis products because they will be finishing products for distribution less frequently, which means fewer fees, which means less money. Cultivators and manufacturers can enter into contracts with individual retailers, but they can also choose to sell to other licensees – distributors or transporters, for example. Distributors will be incentivized to deal with businesses that bring them more money, which leaves smaller firms out, thereby decreasing selection for consumers. The AUMA attempts to give smaller companies a chance through the licensing scheme for cultivators, but if the distributors have their way, that provision may be in vain. Large-scale grows (those with “medium” licenses) will tend to grow a smaller variety of strains

The other possibility is that distributors will buy the yield from smaller companies and store it, which runs the risk of decreasing quality. Unlike liquor, which is distilled and can sit, cannabis flower is sensitive to improper storage.

The fix for this problem is simple: grant different levels of permits as in the cultivation provisions[15], and establish regulations to ensure freshness of products.

General Conclusion

The distribution license, as written, discourages smaller businesses from joining the market, limits selection, and increases cost to consumers. Perhaps the biggest problem with the Type 11 license is that it is wholly unnecessary. It adds another layer of paper and processing in an industry where most cultivators (and manufacturers) would prefer direct contact – while still recording sales to ensure taxes are paid and checking quality – with the people who will be selling their products, instead of having to go through a middleman. The AUMA has undergone some good amendments, but they have not gone far enough. Before Californians enact the AUMA, the drafters should make sure that the Type 11 license won’t get in the way of adult use regulations in business while protecting consumers.

 

[1] He has reportedly contributed $500,000 to the initiative; see the Secretary of State’s list of donors here.

[2] The Los Angeles Weekly published a good account of this dramatic and fascinating story.

[3] Of course, this is either a problem or… not, depending on where you’re sitting.

[4] For full text see AB 243, AB 266 and SB 643, which together comprise the Act.

[5] As it stands, the supply chain mandated by the MMRSA typically goes: Cultivator à Distributor / Tester (either can be first but cannabis or cannabis products must go through both) à Retailer.

[6] Which requires a two-thirds affirmative vote in each chamber – Assembly and Senate.

[7] See AB 266, which added Business and Professions Code Sections 19326(b), (c)(1)-(3).

[8] See AB 266 or Business and Professions Code Section 19328(a)(7).

[9] For an explanation of the other licenses see either here (for this blog’s explanation), or here (for a shorter article brought to you by NORML).

[10] The Bureau of Medical Marijuana Regulation; see e.g., Section 19302 of AB 266.

[11] Evidenced by, among other things, both ReformCA’s initiative and the AUMA relying on the Department of Consumer Affairs to regulate production and distribution, as does the MMRSA.

[12] The AUMA notably does not limit the size or number of distribution firms to mirror the antitrust provisions elsewhere in the Act.

[13] Identity, weight, and content.

[14] The price may still be lower than it is now if production efficiencies increase (which they probably will), but the MMRSA’s provisions have not gone into effect yet, so that remains to be seen.

[15] As the ReformCA initiative made space for with the language, “the office shall establish different tiers of distribution licenses based on the annual gross revenue of the cannabis distribution licensee.” See Section 26028 of the CRTCA.

Concentrated Cannabis: Why does it matter, and how legal is it?

Cannabis concentrates are one of the fastest growing medicinal cannabis products on the market; they have also become increasingly popular among recreational users. Cannabis concentrates are now taking up a larger part of the market for cannabis products overall, with percentage of (overall cannabis product) consumption reaching double-digits among tracked jurisdictions. However, cannabis concentrates have been, and remain, largely unregulated. Any regulatory scheme to be implemented with the new (potential) laws around adult use will have to include the rapidly expanding concentrate market.

This article seeks to: (1) clarify why cannabis concentrates are an essential part of any ballot initiative to regulate adult use while explaining the policy considerations that that initiative must consider, (2) track the sparse legislation that has touched cannabis concentrates, (3) explain the only case so far decided on the legal classification of concentrated cannabis, and finally, (4) assemble those findings to offer policy recommendations on the topic, or at least, to help guide the conversation. As consumption of concentrates rises, the once-niche product has begun to take center stage in the adult use cannabis legalization debate. Both advocates and those opposed feel strongly about the use of concentrated cannabis, and thus it should be a significant consideration in the regulation structure that could be voted into law in November 2016.

As has been adequately documented, the state of California recently passed three bills regarding the regulation of medical cannabis, reforming the long-untouched rules on standards and enforcement of the medical cannabis market. Most of the published reactions so far have centered on the very serious issues of legal regulation, including taxation among growers and retailers (dispensaries), consumer protection via uniform standards, and land and water use.

However, concentrated cannabis – as it is most recently referred to in the law – has remained largely untouched by those bills, despite recent public health concerns. This article will offer some guidance in considering how it may factor into a newly enacted regulatory structure.

Why Do Concentrates Matter?

In the past five to eight years, increasing numbers of patients have turned to using concentrated cannabis instead of the more traditional methods of either smoking the plant (or “flower”) or making/consuming edibles. The sheer volume of use is reason enough to consider legislation specifically aimed at regulating the growing market. However, popularity is not the only reason that California policy makers should consider the importance of concentrated cannabis. There are legitimate arguments both for and against its use, and it has been one of the more polarizing subcategories surrounding the legalization debate.

On the advocacy side: doctors and patients who believe in concentrated cannabis’ medical use. It has been shown to help with epilepsy and related seizures, cancer, and (both chronic and temporary) pain and inflammation. While some of the data around medical use of concentrates is anecdotal, that should not prevent a regulation structure from taking advantage of the potential medical uses for concentrates, if they even suggest that there may be anti-carcinogenic effects, as well as generally beneficial effects for those who are suffering. Any new state law should provide for, at least, deeper medical research regarding the benefits of concentrates.

The opposition: some research professionals who are skeptical about its medical benefits outweighing the cost of regulation and the risks surrounding the potential danger of production (which I will address in a later article) of concentrates, buffeted by the classic Reefer Madness-style prohibitionists.

The very existence of such vehement advocacy on both sides of the issue is perhaps the most persuasive argument for making regulation of concentrates a central part of the conversation around cannabis regulation reform.

The policy problems that concentrates present are relatively few, when compared to the policy maelstrom of cannabis regulation writ large. The main fears around use of concentrates stem from their recent upsurge in popularity. Concentrates remain shrouded in mystery in a market that already struggles for transparency – doctors want to know whether they are medically beneficial; patients and recreational users want access to medication / high-quality concentrates that are of dependably consistent quality.

This article will now turn to an examination of legislation following the Compassionate Use Act (aka Prop. 215) to the present, to see how concentrates have been treated within the law thus far.

Recent Bills: AB 243, AB 266, SB 212, SB 643

Of the four recently enacted bills, only two of them even make mention of concentrated cannabis; they deal exclusively with the manufacture and classification of cannabis concentrates. They are Assembly Bill 266 and the less recent Senate Bill 212, the former of which simply defined the term “cannabis concentrate,” and the latter of which enhanced the sentencing guidelines for manufacturing cannabis concentrates close enough to people (300 feet) to cause harm.

AB 266 provides a definition of the term “cannabis concentrate.” It explains under section (g), “‘Cannabis concentrate’ means manufactured cannabis that has undergone a process to concentrate the cannabinoid active ingredient, thereby increasing the product’s potency.” The simple definition is intuitive, and provides little structure regarding the law’s influence on the regulation of concentrated cannabis. Luckily, the section’s second sentence provides perhaps the most helpful actual guidance in terms of concentrated cannabis regulation: “An edible medical cannabis product is not considered food, as defined by Section 109935 of the Health and Safety Code, or a drug, as defined by Section 109925 of the Health and Safety Code.” The law lumps together “concentrated cannabis” and “edible medical cannabis” in the same definition, which means that “edible medical cannabis product[s]” fall under the law(s) dealing with concentrated cannabis.

Food as it is defined in Section 109935 is similarly unhelpful. Food is either “(a) Any article used or intended for use for food, drink, confection, condiment, or chewing gum by man or other animal. [Or] (b) Any article used or intended for use as a component of any article designated in subdivision (a).” This article treats the two as the same for that reason, all the while recognizing that in reality what are referred to as “concentrates” are very different from what are referred to as “edibles.”[1]

Sometimes when we are working within the confines of vaguely worded laws, the most instructive information is in what the law is neglecting to say, or as here, what sections do not apply. Surely in this case that is the best thing to do since the only guidance as to concentrated cannabis’s legal treatment is in the negative – which is to say, the definition section makes no mention of any applicable section, but it does specifically mention two sections that do not apply.

The section concerning the definition of a “drug” – 109925 – is slightly more helpful, but again, only because concentrated cannabis does not fall within its domain. A “drug” is one of the following: “(a) Any article recognized in an official compendium. (b) Any article used or intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease in human beings or any other animal. (c) Any article other than food, that is used or intended to affect the structure or any function of the body of human beings or any other animal. (d) Any article used or intended for use as a component of any article designated in subdivision (a), (b), or (c) of this section.” The fact that concentrated cannabis is not classified as a drug means that it escapes the regulation of this section, too. Concentrated cannabis seems to fall under (c), which would make it a “drug” under California Law – it is indeed “used or intended to affect the structure or any function of the body of human beings.” However, there is one likely reason that the definitions are worded this way, which is that the definitions of food and drug follow federal law, which regulates both of those items on a baseline level, whereas cannabis is still illegal on a federal level. The fact that those sections are not applicable to the sale and regulation of concentrated cannabis means that concentrated cannabis is, yet, almost completely unregulated.

Senate Bill 212, later codified at CA Health and Safety Code section 11379.6, was introduced by state Senator Mendoza following several accidents involving people who were attempting to manufacture concentrated cannabis in their homes [discussion of the accidents is in the next installment]. The bill amended the version of section 11379.6 that already existed, which provided that, “(a) Except as otherwise provided by law, every person who manufactures, compounds, converts, produces, derives, processes, or prepares, either directly or indirectly by chemical extraction or independently by means of chemical synthesis, any controlled substance specified in [sections 11054-11058] shall be punished by imprisonment . . . for three, five, or seven years . . . and by a fine not exceeding $50,000.” Subdivision (a) as listed already existed in the old version of the statute, but is important for foundation.

The amendment provides for a new subsection (d), which reads: “The fact that a violation of this section involving the use of a volatile solvent to chemically extract concentrated cannabis occurred within 300 feet of an occupied residence or any structure where another person was present at the time the offense was committed may be considered a factor in aggravation by the sentencing court.” The amendment came on the heels of several reports of explosions in residences that started when the cannabis concentrator was careless with the “volatile solvent,” which is usually butane, a highly flammable gas. Butane is used to “chemically extract” the tetrahydrocannabinol (THC) from the cannabis plant, but if there is any spark or open flame near the gas, it will explode. This amendment was shaped by public health concerns surrounding collateral damage. In the court decision explained below, the concern was not public safety as here, but the definition of (medical) concentrated cannabis itself.

Concentrated Cannabis in the Court:

At the end of last year, a unanimous panel at the California state appellate court for the third district ruled in People v. Mulcrevy that concentrated cannabis qualifies as medical marijuana. The court was considering the question in the context of 22 year-old Sean Mulcrevy’s probation violation for possession of concentrated cannabis. Mulcrevy, the government alleged, had violated his probation by failing to “obey all laws,” as he was bound to, per the terms of probation. Mulcrevy is a medical marijuana patient who was charged with unlawful possession of concentrated cannabis – a misdemeanor – in 2013.

The Sacramento Bee reported that despite “review[ing] existing legal authority indicating that concentrated cannabis is covered by California’s Compassionate Use Act,” Superior Court Judge James R. Wagoner decided that concentrated cannabis was not covered. He rejected the authority as “unsound,” instead ruling against Mulcrevy, explaining that “‘the (CUA) does not apply to concentrated cannabis’ because the act does not define marijuana, refer to concentrated cannabis or incorporate statutory definitions of either term.” Why that would prevent a judge from ruling that concentrated cannabis was in fact included within the Act’s reach is a mystery. Medical cannabis in plant form contains the same active ingredient as concentrated cannabis; one can commonly purchase cannabis concentrates at medical cannabis dispensaries. Regardless, this court decision helped to shape one of the new amendments, AB 266, and undoubtedly informed the drafters that they needed to, at the very least, define the term to preclude further confusion in the courts. And that is just what they did.

Policy Considerations Going Forward

As is probably obvious, regulation of concentrated cannabis has remained largely stagnant. Concentrates have been flying under the radar, but their growing popularity and the surrounding debate necessitates regulation. As mentioned above, there are several key interests here that should be addressed: doctors want to know whether they are medically beneficial; patients and recreational users want access to medication / high-quality concentrates that are of dependably consistent quality.

Thus, any regulatory scheme should account for further medical research into concentrates. There are several sources, including the newest chief of the DEA, that have argued for concentrates’ medicinal value, and at the very least, it should be explored so that the scientific and healthcare communities can reach a consensus. Production should be limited to approved, safe (and possibly butane-free) facilities where experienced staff process the cannabis to concentrate it, but those facilities should be allowed to maximize output, which will minimize the draw for private actors to (dangerously) attempt to manufacture concentrates at home.

Making sure that the manufacturing process is safe and consistent will in turn lead to a higher quality product because assuring those aspects of concentrate regulation will naturally lead to an increase in purity, with fewer additives. When regulation of production is coupled with medical research, both medical cannabis patients and recreational users will be able to get safely processed, consistently high-quality concentrates, while cutting down on (and eventually eliminating) the dangerous private manufacturing processes that has left concentrates as the stigmatized cannabis outsider in a burgeoning market.

 

[1] Edibles are, in fact, made with concentrated cannabis, but the concentrate is infused into cooking oil or butter, as opposed to being processed to reap wax or hash, which are largely inedible substances designed to be inhaled.

Marijuana Patients Facing Eviction: Responding to an Eviction Action

A recent article on Canna Law Blog touched on aspects of the landlord/tenant relationship that have been taking center stage in the marijuana policy debate in states where recreational marijuana or medical marijuana has been legalized. The article correctly provided a detailed overview of eviction actions as they apply to marijuana dispensaries and importantly focused on the specific laws and regulations that govern commercial tenancies. As marijuana dispensaries pop up throughout the United States, a multitude of legal issues will arise with them. For example, are all marijuana contracts illegal as contrary to public policy? In other words, given that marijuana is not yet legal at the federal level, are people who contract with marijuana dispensaries forming an illegal, unenforceable contract? These questions will be addressed in articles to come.

For now, I will focus on one specific contract: the tenancy lease. Many articles have correctly analyzed issues arising out of commercial tenancies (such as dispensaries). While some articles have accurately indicated that commercial evictions are often based on allegations of “illegal activity,” many have improperly classified the issues as applicable to all landlord and tenant relationships. I intend to set the record straight.

This article is part two of a mini-series that examines the substantive aspects of eviction actions filed against tenants who use marijuana. It will provide tenants with a detailed description of the arguments a landlord may make in an eviction action for marijuana use.

Part one gave tenants some background on their right to a jury trial and encouraged tenants to use this right to leverage negotiations in their favor. Over the past two years of both attending court to assist in client representation and observing the unlawful detainer calendar on a weekly basis, I have seen only ONE defendant request a jury trial. The judge in that case firmly declared that he would never deny a defendant’s right to a trial by jury. I was motivated to write the last article because the judge’s statements caused a change in the landlord attorney’s attempt to reach an agreement and negotiate the case. The landlord attorney walked back and forth between the defendant and his client in an attempt to get them to reach an agreement so as to avoid the lengthy (and might I add, expensive) trial.

The goal of this article is to provide tenants with additional leverage in settlement negotiations. As described in the pervious article, there are many benefits to settlement such as: reduced expenses, reduced stress, privacy, predictability, saved time, and (perhaps most importantly) flexibility with regards to the outcome. While a judgment may be legally correct, the outcome may not always be fair to both tenants as one will ultimately end up with nothing (other than a hefty attorney bill). Settlements allow for both sides to potentially reach terms that are mutually beneficial. Ultimately, this article will provide tenants with information that, if used in negotiations, will result in fair outcomes.

First, I will examine the specific laws that allow a landlord to begin an eviction action. Second, I will explain what the laws mean for a tenant and how a landlord may use the law against a marijuana user. And third, I will lay out the potential arguments to be raised by the tenant.

Disclaimer: This post is intended to provide general information about your rights as a tenant. It should not be understood to provide legal advice. Should you receive any court documents, please contact an attorney regarding your particular issue.

The Law: Evictions in General

As discussed in my previous articles, an unlawful detainer action (eviction action) is the process by which a landlord may legally evict a tenant. Evictions arise for many reasons. Perhaps the most common are non-payment of rent and breach of the lease agreement.

Under California law, and for the purposes of this article, a landlord is a person who owns a residential rental unit. The landlord rents the unit to a tenant for that tenant to live in. The only person or entity that has standing to evict a tenant is the owner of the property. As discussed earlier, the landlord may evict tenants for their actions as well as their guests’ actions. In most instances, a tenant’s guests are, in the eyes of the law, an extension of the tenant named on the lease agreement. Unlike standing, where only the landlord may begin the eviction action, if a tenant’s guest is smoking marijuana on the premises, the law views this as if the tenant himself is the one smoking marijuana.

What Gives Rise to an Unlawful Detainer Action?

Eviction actions in California are governed by the California Code of Civil Procedure Section 1161(3). This section provides that a tenant who has failed to perform a condition or covenant of the lease agreement is guilty of unlawful detainer if the tenant has been served with a “3-Day Notice.” In other words, a landlord who suspects that a tenant is using marijuana in his unit may begin the eviction process by serving a “3-Day Notice.”

The Notice must:

  1. Be in writing;
  2. Say the full name of the tenant or tenants;
  3. Have the address of the rental property;
  4. Say what the tenant did to violate the lease or rental agreement; and
  5. Say the tenant has the chance to fix the problem or move out in 3 days.

Tenants who have been served with a “three day notice” should make sure that it complies with the statutory requirements. Failure to comply with any of these requirements will render the entire case moot and force the landlord to reissue the notice until it complies with all the requirements. Courts have given the requirements of Section 1161(3) strict interpretations. This means that the landlord must meet all the requirements and that if he fails to meet these requirements (even slightly) courts must rule in favor of the tenant. For example, where a landlord fails to include the total amount of rent due in a “3-Day Notice,” courts will generally require the notice to be corrected and served again.

If the landlord files an eviction action based on a faulty notice, they will have wasted approximately three weeks in court proceedings only to show up to court and be told that they will need to serve the tenant with an adequate notice. This means more time for the tenant to remain on the premises and to try to negotiate with the landlord.

Given the fact that most (if not all) lease agreements include a “no smoking provision,” using medical or recreational marijuana in a rental unit is likely to constitute a violation of a tenant’s lease agreement. Therefore, if a lease agreement prohibits smoking, Section 1161(3) allows a landlord to serve the much-dreaded “3-Day Notice” and begin the eviction process. However, at this point, the tenant is not yet “guilty” of unlawful detainer.

Failure to Perform a Covenant or Condition of the Lease Agreement

Tenants should review their lease agreement to verify that the lease agreement does in fact include such a provision. If a lease agreement fails to prohibit smoking, this specific argument may not be used against the tenant. The reason for this is that a tenant cannot be in breach of a lease provision that does not exist in their lease agreement.

It’s important for tenants to be aware that a landlord has, at his disposal, many other arguments that he may raise in a marijuana eviction case. For example, violations of implied or express covenants, such as creating a nuisance, possession of an illegal substance, or using the unit to carry out illegal activity, are all grounds for a landlord to initiate the eviction process. Unlike the “no-smoking” provision, these violations exist regardless of whether they were expressly included in the given lease agreement. Landlords have an unconditional [statutory] right to raise these arguments. Likewise, tenants have a duty to comply with them.

When is a Tenant “Guilty” of Unlawful Detainer?

Within the context of the “no-smoking” provision, using marijuana in an apartment is a breach of the lease agreement. This breach allows the eviction process to begin; however, it does not necessarily mean that a tenant is guilty of unlawful detainer. Despite the law’s language favoring landlords, a landlord that decides to pursue an eviction action still bears the burden of proving that the tenant has committed an unlawful detainer. Ashlers v. Barrett, 4 Cal.App158, 160 (1906).

How does a landlord prove that a tenant is “guilty” of unlawful detainer?

In order to prove that a tenant is “guilty” of unlawful detainer the landlord must show: 1.) that the marijuana usage at issue in the case constitutes a material breach and 2.) that the tenant has failed to vacate the unit within the notice period. Given the fact that the second element is very easy to prove, this article will focus on the first element.

First, the landlord must have proof that a tenant in fact breached the lease agreement by committing a specific act that the lease agreement prohibits. Where marijuana is involved, it may be based on testimony from someone who observed the tenant using marijuana. Unless a landlord or neighbor can testify under oath that he saw the tenant using marijuana, the landlord will likely run into problems trying to prove that the tenant actually used marijuana on the premises.

Many landlords don’t live on the same premises as their tenants; therefore, complaints about marijuana are likely to come from other tenants who claim that they can smell pot. This argument is weak, primarily because it is difficult to show that the smell is actually coming from one particular unit (assuming the tenant hasn’t taken it upon himself to “hot box” the apartment unit). In an eviction action that does not involve an eyewitness, the tenant will likely be required to testify under oath. Tenants should be aware of the consequences of lying under oath. If a tenant has indeed used marijuana on the premises, it’s in their best interest to try to negotiate a settlement. However, a tenant who has used marijuana on the premises can use this lack of evidence to negotiate additional time to move out or possibly enter into a probationary tenancy.

Second, the landlord must prove that the marijuana usage in that particular instance constitutes a “material breach.” Courts have declared that breaches that are only technical or trivial (as opposed to “material”) will not support forfeiture in an unlawful detainer action in an unlawful detainer action. See McNeece v. Wood, 204 Cal 280, 285 (1928). Hence, even if a tenant has been seen smoking marijuana in their rental unit, the tenant is not necessarily guilty of unlawful detainer unless the particular instance is so severe that it constitutes a “material breach.” For example, smoking marijuana in a rental unit every day is very likely to constitute a material breach. However, a single time that involved a guest is not likely to constitute a material breach because most courts recognize that one instance is not significant enough to result in an eviction.

While not covered extensively in this article, tenants should keep in mind that they have additional defenses such as substantial compliance with a covenant. Knight v. Black, Cal. App. 3d. (1985) Additionally, courts have not drawn a clear line between a trivial breach and a material breach. Thus, even where a given breach is deemed “material” the tenant may still argue that enforcement would be unconscionable and inequitable.

My next article will specifically look at marijuana evictions as they arise in public housing. As discussed in a previous article, while landlords are required to follow the eviction process requirements for all tenancies, public housing tenants stand to lose much more. I will also analyze the potential effects of a recently proposed HUD regulation.

Remember, this is an article, not an attorney. If the above matters apply to you please seek legal advice from you local Legal Aid or pro-bono attorney.

No Big Marijuana, Please: Medium is as Big as we Get

The spectre of Big Marijuana is often raised as a problem to be avoided in legalized markets (including, it must be said, by the Blue Ribbon Commission, of which I was Public Safety Chair). Though Big Marijuana is most often discussed in the context of adult-use markets, it is also of concern in the medical market—particularly one as large as California’s. The new regulations (AB 266, SB 643, and AB 243) no longer require market participants to be patients, and they no longer exclude for-profit companies. This doesn’t mean, however, that Big Marijuana is inevitable. California’s new medical marijuana regulations address concerns about market concentration in a number of ways, particularly when it comes to licenses.

At the outset, AB 266 allows for three sizes of cultivation license, each one bigger than the other. But taking a page from Starbucks (or Orwell), these are not small, medium, and large licenses: instead, they are specialty, small, and medium licenses. That’s right: the largest size of 3 cultivation licenses is a medium. To be fair, these cultivation sites aren’t all that large, as is spelled out in AB 243. The smallest licenses (type 1, or specialty) are 5000 square feet of canopy or less, the medium—er, small/type 2—size is between 5001 and 10000 square feet of canopy, and the “bigger than small but not large” medium/type 3 licenses are 10,001 square feet to an acre for outdoor grows and 10,001 to 22,000 square feet for indoor and mixed-light grows.. The Department of Food and Agriculture “shall limit the number of licenses”, but, as with many areas covered by the new regulation, substantive details about the limited numbers are going to be worked out administratively.

In addition to cultivation licenses, there are licenses for distribution, testing, dispensaries, and manufacturing. Distribution licenses can only be combined with testing licenses; they may not be combined with other kinds of licenses. This seems familiar enough, taking a page from the alcohol producer/wholesaler/retailer model–except that there is also a carveout for combining licenses. It is possible to hold cultivation, manufacturing, and dispensary licenses provided the dispensary license is 10A (permitting a maximum of three locations) and the total area of cultivation is not more than 4 acres of canopy.  This suggests that vertical integration on a smaller scale (Medium Marijuana) is permissible. Not being a horticulturalist, I’m not sure whether 4 acres of canopy is a sufficient limitation to prevent market concentration—it would depend on the yield of those four acres and on the number of “medium”/type 3 cultivation licenses that are ultimately authorized. We might also need to consider geographic/local market concentration as well. Given the relationship between state and local regulations, it might still be possible to have geographic concentrations of stores or cultivation sites that could result in local Big Marijuana, but this would, of course, depend on whether the local permitting system enabled that.

Finally, note that the licensed market does not include everyone authorized to grow medical marijuana. Individual patients can still grow their own marijuana, though they are limited to 100 feet of canopy and are not permitted to sell or even give away any of what they grow. Caregivers are allowed to care only for 5 patients at the most and their compensation is limited by 11362.765(c) (limiting compensation to, generally, expenses and that which is “reasonable”).  Already, one pro-patient group has indicated its displeasure with these new limitations and has threatened to sue on the grounds that the legislature has taken away rights granted by Proposition 215, a claim which, if true, would indeed invalidate the provisions. However, it is unclear whether Prop 215 granted an explicit right to be a caregiver for, say, more than 5 people or to grow for personal use with a total canopy size that was either unlimited or at least bigger than 100 square feet. At least for these patient groups, the medium sized marijuana market, personal edition, is not nearly large enough.

Is the Era of De Facto Legalization Over in California?

After a summer hiatus, we are back at the Drug Law and Policy Blog. I have a team of students who is going to help me cover the latest from the world of California marijuana regulation, but we’re going to start by walking through some of the huge changes wrought by a trio of bills: AB 266, SB 643, and AB 243, which, almost 20 years after the Compassionate Use Act (CUA) ballot initiative (also known as Prop 215), provide for statewide regulation of medical cannabis.

California has been described as having de facto adult-use legalization because it is so easy for people to get medical recommendations for marijuana use. Indeed, I have often heard in conversation with folks around the state that the reason the prior legalization initiative, Prop 19, failed—and why any future proposition might fail—is that the existing system worked well for everyone involved: people who wanted marijuana could easily get it. (This ignores other things that consumers might want, such as reliable testing and safety of products, many of which are covered in this new set of regulations.) Did the recent legislation change anything?

Nothing has changed about the qualifying conditions eligible for marijuana, which are set by the CUA and are quite broad. Instead, in this post I’ll focus on the other ways in which the medical market might constrict: regulating doctors who issue the regulations, regulations which are laid out in SB 643.

There are a number of “plain vanilla” regulations of the doctors who write recommendations, including requirements for disclaimers in advertising and prohibitions on doctors having any financial arrangements with licensees (punishable by up to a year in jail). There is a requirement that the recommender be the patient’s “attending physician”, but the definition of attending physician is given a particular meaning in Health and Safety Code 11362.7, and merely refers to a medical doctor or osteopath who has “taken responsibility for an aspect of the medical care, treatment, diagnosis, counseling, or referral of a patient and who has conducted a medical examination of that patient” (emphasis added) before issuing the recommendation.  As long as there is an examination, then, and there is some responsibility for some part of the person’s medical care, a doctor can issue a recommendation.  (Of course, a more restrictive definition of “attending physician” or what it means to “take responsibility” for an aspect of a patient’s care could limit the pool of those who could write recommendations, but the rest of this post will focus on different language, since the new legislation adopts these definitions without necessarily changing them.)

The two new limitations on recommendations, as I see them, come from changes to the Business and Professions Code § 2220.05, which establishes the “investigative and prosecutorial resources” of the Medical Board of California. Here, SB 643 made investigations and prosecutions of doctors who engage in “[r]epeated acts of clearly excessive recommending of cannabis to patients for medical purposes, or repeated acts of recommending cannabis to patients for medical purposes without a good faith prior examination of the patient and a medical reason for the recommendation” the fourth-highest priority for the Medical Board, just above sexual misconduct with a patient and just below a more generic prohibition against excessive prescribing of controlled substances. Of course, we don’t necessarily know just from the statutory language what a “clearly excessive” number of recommendations might be, nor is it clear either what a “good faith examination” of the patient is nor how many bad faith examinations constituted “repeated acts.” Nevertheless, there are some limits here.

Elsewhere in the bill there is a requirement for the Medical Board of California, in concert with the (newly established) Center for Medical Cannabis Research, to work on “developing and adopting medical guidelines for the appropriate administration and use of medical cannabis.” If one reads “administration and use of cannabis” to include the decision whether or not to recommend usage at all, this might provide some clearer guidance to doctors—and the Medical Board—about who is engaged in unprofessional (and license threatening) conduct.

So why would this matter? California’s medical marijuana industry is so large, in part, because the number of “patients” who can buy medical marijuana is so large. If the state begins to crack down on a few doctors who provide a large number of recommendations (and I don’t have any reliable information about how many doctors, if any, there are, nor about how many recommendations they provide), then we might see the size of the medical marijuana market start to shrink. One of the reasons I’ve been less than sanguine about the prospects for the electoral prospects of ballot initiatives to allow adult use in California is that, for many market participants, medical marijuana ain’t broke, so it doesn’t need fixing. Starting to distinguish between overly permissive doctors and those with some kind of established relationship with their patients might change the economics of the established medical marijuana market, and, with it, the electoral calculus as well. But it will all depend on how the statutory language is interpreted and on how effective enforcement activity is.

Marijuana Patients Facing Eviction: Why you should put your fate in the hands of twelve people who weren’t smart enough to get out of jury duty.

During my first year of law school, I lived in the bottom floor of a two-story, luxury apartment building near campus. Above me lived a couple of twenty-something-year-olds that liked to have very loud (and might I add disturbing) parties until the early morning. After several useless complaints about the noise, I gave up hope that my neighbors would stop partying and that my landlord would ever give them any kind of warning.

Anyone who has ever rented an apartment knows that, like my complaints about the loud parties, neighbors find things to complain about. Whether warranted or unwarranted, marijuana complaints are also a common source of neighbor disputes. Having spent the past year and a half representing defendants in landlord-tenant actions, I’ve witnessed my share of neighbor complaints.

Regardless of the nature of the complaint or the severity of the lease violation, one trend has been clear: landlords and tenants can reach a peaceful resolution in most cases. What this means for tenants is that they are very unlikely to have to argue a case before a judge or jury.

Now that marijuana is readily available for those living with severe health conditions and even more available in states where it has become legal, neighbor disputes about “the funk next door” are likely to take center stage in many eviction actions. Due to the recent changes in marijuana laws and the fact that very little case law is available, marijuana evictions must be analyzed against other comparable eviction cases. That said, medicated patients facing evictions can take a momentary sigh of relief knowing that there are other options. The key is to know the arguments available. Using these arguments will allow a tenant to get the best possible settlement.

My past articles have explored the discretion enjoyed by landlords when determining whether to evict a tenant believed to be using medical marijuana (marijuana eviction case). I have also described the extensive process a landlord must undergo before evicting a medical marijuana patient.

This article constitutes part one of two that will give those facing an eviction action a substantive overview of the arguments a landlord is likely to make. It will also suggest some possible defenses that may be used by a tenant.

The right to a trial by jury: arguably the tenant’s most valuable leverage in negotiations.
Most tenants are not aware of their constitutional right to a trial by jury in an eviction proceeding. This tool is especially strong in a marijuana case for several reasons:
1.) The Cost of Going to Trial: Low-income tenants often qualify for fee waivers while landlords do not. This means that tenants can file motions and make other requests at no cost, while landlords will have to spend hundreds of dollars to make responsive pleadings.
2.) The Preparation for Trial: Landlords and their attorneys will have to gather witnesses and bring them to trial with them in order to prove up their case. This costs landlords travel time as well as attorney hours.
3.) Loss of Rent Money: Jury trials in unlawful detainer proceedings may take anywhere from two to three months. During this time, landlords cannot accept rent from the tenant because accepting rent may constitute a waiver of their cause of action and can be used against them at trial.
4.) The Landlord Loses Even if he Wins: Even if landlords succeed at trial, an unlawful detainer proceeding is strictly meant to determine rightful possession of the unit. What this means is that despite winning at trial, and despite any money judgment awarded, the landlord must pursue compensation in a separate action.

The threat of a jury trial will allow the tenant to bargain for more time to remain in the unit while they find a new place to stay. Depending on the situation, the tenant may be able to remain in the unit and bargain for a probationary tenancy.

My next article will compare arguments made in unlawful detainer cases as they are the most likely to be used in marijuana cases. I will describe substantive arguments a tenant may use if and in the unlikely case that they end up in trial.

Disclaimer: This post is intended to provide general information about your rights as a tenant. It should not be understood to provide legal advice. Should you receive any court documents, please contact an attorney regarding your particular issue.