Leasing California Cannabis Real Estate- Must Know's:
Twenty nine states plus the District of Columbia have legalized medical marijuana and eight of these states plus D.C. have legalized recreational marijuana. Additional states are considering some form of legalized marijuana use. This has created a new and growing demand for leasing industrial, agricultural and retail properties for growing, manufacturing and dispensing cannabis. Given this growing demand for real estate, it is important to reflect on how many boilerplate provisions in commercial leases are not suited to covering a use that continuously puts state law at odds with federal law.
Despite the ground swell of support for the legalization of recreational marijuana coming from state governments, the federal government remains antagonistic and recent statements from Attorney General Jeff Sessions suggest the possibility of increased enforcement of federal laws prohibiting the production, distribution, sale, purchase and/or possession of marijuana. Three days after California’s legalization of recreational law went into effect, the Attorney General rescinded the “Cole Memo,” which had directed U.S. attorneys not to use limited federal resources to prosecute violations of marijuana laws, and it remains to be seen how the federal government will proceed in enforcing the Controlled Substances Act with respect to the producers and distributors of medical and recreational marijuana. With that in mind, below are several boilerplate provisions that deserve, if not require, a fresh look in commercial marijuana business leases.
Governmental Compliance. It is common in commercial leases to have tenants covenant that they will comply with all applicable federal, state, county, municipal and other governmental statutes, laws, ordinances and regulations. The possession, production, distribution, sale, purchase and possession of marijuana remains a federal crime, so a tenant would be in automatic default under a typical commercial lease for non-compliance with federal law if this covenant is not revised accordingly.Further, the lease should address the contingency that the tenant may not be successful in obtaining the necessary permits and licenses for operating a marijuana business. As a condition precedent to tenant and landlord’s obligations under the lease, the lease should require that tenant obtain all necessary governmental licenses and permits for the operation of the tenant’s specific marijuana business. If the tenant is not successful in its application, both parties should have the option to terminate the lease, and the landlord may want to seek liquidated damages to compensate for any costs incurred by the landlord in connection with the transaction.
Early Termination. As with any lease for property used for an industry of questionable or conflicting legality, what both parties understand to be a legally enforceable contract for a legally permitted use may not be enforceable in two years, six months or tomorrow. Beyond the early termination right relating to the a tenant’s permit contingency, landlords and tenants should consider drafting other early termination rights into the commercial marijuana lease. For example, the parties should be able to terminate the lease if there is a judgment entered by a court having jurisdiction over the premises that the use of the premises constitutes a public or private nuisance or if there is a change in applicable state or federal law that would materially limit the ability of the tenant to conduct its business on the premises or subject the landlord to unreasonable risk of forfeiture of the premises.
Common Area Maintenance and Utility Costs. Businesses producing and/or selling marijuana often incur increased utility and security costs due to the energy- and water-intensive nature of producing marijuana and the strict regulations required by licensing agencies. A commercial marijuana lease should address the equitable allocation of these costs, especially in multi-tenant buildings.
Prohibited Use and Nuisance Provisions. Another common provision in commercial leases is a prohibition on uses that constitute a nuisance for neighboring tenants or property owners. Generally, leases will include prohibitions on uses that emit an offensive or obnoxious odor, fume, dust, vapor, noise or sound that can be heard or smelled outside the premises, but in other commercial leases, there can be more specific use restrictions for certain types of businesses, for example, liquor stores. A landlord will need to make sure that permitting marijuana production or sale uses will not violate any of the landlord’s other leases for neighboring properties or any documents recorded against the premises, and a tenant will want to make sure that any nuisance provision in its lease contains a carve-out for the operation of a marijuana production facility and/or dispensary.
Rent Payments. Retail leases often include a “percentage rent” provision through which the landlord receives a percentage of the tenant’s gross sales above a certain threshold in addition to base rent. Landlord may want to avoid this arrangement, since it may subject them to scrutiny by the applicable governmental agency licensing the marijuana business. If the landlord is deemed to be receiving some portion of the profits from the marijuana business as rent, the agency may require certain disclosures from the landlord, since the agency could take the position that the landlord is receiving the benefits of an owner of the marijuana business.
Insurance. As part of the boilerplate language, commercial leases often require tenants to maintain property insurance for the replacement of tenants’ personal property, including inventory. Not all insurers, however, would cover the loss of marijuana inventory. Since marijuana is illegal under federal law, commercial leases for a marijuana businesses should contain an alternate insurance provision to control for a potential denial of coverage. The insurance provision could be revised to allow the tenant to self-insure or to require the tenant to obtain supplemental insurance through marijuana industry-specific insurance companies to cover any property the primary insurer won’t cover. At the minimum, a tenant should be deemed to self-insure and must waive all claims against the landlord for loss or damage to its personal property, including inventory, that will apply if any portion of the tenant’s personal property is destroyed by casualty. In any event, the tenant should be required to disclose to the insurance company that it is a marijuana business.
Arbitration. Of further concern, given the increasingly national nature of legal marijuana production and distribution, is the potential for any dispute over a commercial marijuana lease to be removed to federal court, in which case the entire contract could be held unenforceable under federal law. A commercial marijuana lease should address this concern by providing for mandatory arbitration or, in the alternative, designating the state court in the state where the premises are located (and the use legal) as the mutually agreed upon and exclusive venue.
Considerations Beyond the Lease. Outside of the lease itself, a landlord will also want to consider whether leasing space to a marijuana business violates the terms of any existing security instrument affecting the property, and how a marijuana business lease may affect the landlord’s future ability to get financing secured by the premises. There is also the risk that the premises could be subject to civil forfeiture if federal prosecutors can establish a “substantial connection” between the premises and a federal crime.