Cannabis Musings - April 2, 2024
You can't enforce my contract - it's illegal!
Friends, that clicking you heard at around 4pm Eastern Time on Monday was the sound of #cannabis investors furiously hitting refresh on the Florida Supreme Court’s website, waiting for the court’s opinion on whether it would allow a question on adult use cannabis to appear on the state’s November ballot. Spoiler alert: the court allowed it. As closely as that case was being followed by industry watchers, however, many cannabis law wonks were actually more interested in a lesser-known federal court case.
First reported in Law360 a few weeks ago, David Joshua Bartch v. Mackie A. Barch and Trellis Holdings Maryland, Inc., in the 10th Circuit Court of Appeals, discusses one of my (many) favorite topics in cannabis law – the illegality defense. We’ve talked about this mechaye before, when, om one of the funniest cannabis lawsuits ever, MedMen tried to get a federal court to let it out of its New York real estate lease because cannabis is illegal, making the lease unenforceable as a matter of policy. Pure chutzpah. Tsegait zich in moyl. (“It melts in your mouth.”) (Astute readers of these Cannabis Musings know that the other funniest cannabis lawsuit is the 1981 Tax Court case that gave rise to IRS Code §280E.)
The case itself is a dispute over an ownership agreement between investors in a Colorado-based, plant-touching cannabis operator. The facts aren’t terribly relevant, so much as the gist of the issue in front of the federal court – whether a contract about a cannabis business, but not for the cannabis operations themselves (e.g., a wholesale purchase order), is enough of a violation of federal law for the court to refuse to enforce it. In other words, if the court were to enforce the contract, would it be compelling a violation of federal law. Generally, if you want to sue your source over, say, a shipment of bootleg DVDs of The Producers (the original one with Zero Mostel, of course), you’re not likely to get very far in federal court (that’s not legal advice, but it’s kind of self-explanatory).
Law360 reported on March 19th about the oral arguments in the case, which got into questions about whether the payment that was to be made would come from cannabis operations versus other assets:
“Assuming that your clients did have assets independent of the business and could satisfy the award … [w]here’s the violation of the Controlled Substances Act?”
And, whether the CSA even deals with activities that are ancillary to plant-touching operations:
“‘I scratched my head to figure out why this is illegal,’ the chief judge said.”
This all comes out in the briefing (the court filings by counsel arguing their sides of the issue) as well. The appellant argues:
“The issue is whether relief can be granted without violating the law. The relief Bartch seeks is damages based on his alleged ownership interest in Culta, i.e. a portion of Culta’s profits. After Culta made millions of dollars from the sale of marijuana, the district court awarded Bartch a portion of the profits. This relief was outside the power of the district court as it is a direct violation of the CSA.”
It's an interesting distinction, one that federal appellate and district courts have held up before, including in RICO and labor law cases, and tries to thread the needle between direct and indirect cannabis activities. It’s very much akin to the difference between plant-touching and ancillary cannabis businesses – the former is handling the product itself, while the latter is providing goods and services to the former.
Take, for example, my (hypothetical) infused knish company. I purchase from a supplier the THC extract (assume it’s not hemp-derived, because that’s a whole other rabbit hole) that makes my potato treats special under an agreement drafted by the law firm of Dewey, Cheatem & Howe LLP. The supplier and my company are plant-touching and directly violating the CSA. The law firm, however, is an ancillary business, since it’s providing services to my company, but not itself handling cannabis.
The law firm is potentially at risk for violating a whole host of federal laws, particularly those relating to money laundering (assuming I pay them, of course!), the Federal Food, Drug, and Cosmetic Act, the Federal Wire Act, and RICO, as well as possibly aiding-and-abetting my knish company to violate the CSA. Isn’t cannabis fun? Now, this has proven out to be a pitseleh risk, although impossible to eliminate. While many businesses like the credit unions banking the industry, fertilizer supply companies, and utilities powering operators have accepted the risk, the ones that haven’t tend to be those that are federally licensed, like financial institutions (e.g., banks, broker-dealers, stock exchanges), and alcohol and tobacco companies. Why lose your license to pick up a modest amount of new business? (None of this is legal advice.)
The one fun exception to the ancillary business problem is the landlord that rents property to a plant-touching company. If they know that their tenant is a cannabis operator, they’re directly violating the CSA, even though that landlord isn’t itself touching the plant. Unfortunately known as the “crackhouse statute,” it’s an interesting twist that’s the basis for why (for the most part) cannabis real estate investment trusts aren’t listed on US stock exchanges.
So, this brings us back to the 10th Circuit case. Is it enough that the dispute is over a contract that’s between investors in a cannabis company, but arguably doesn’t directly involve the company or its operations? It’s kind of like the distinction between plant-touching and ancillary businesses. Where in that liminal space do we draw the line?
If we see the 10th Circuit find that federal courts indeed cannot enforce these kinds of contracts, then we’ll have something of a circuit split – one federal appellate court ruling in conflict with the ruling of a federal appellate court (which can happen because they’re not bound by each other’s decisions – only the decisions of the U.S. Supreme Court). I qualified that because the other cases out there aren’t directly on point, but they’re in the neighborhood.
It would also mean that all sorts of contracts relating to cannabis companies in Colorado (and New Mexico, Utah, and Oklahoma) won’t be enforceable in the federal courts within those states. That would not be good for business.
More speculatively, and more spectacularly, that kind of circuit split could get taken up by the U.S. Supreme Court. SCOTUS loves to resolve circuit splits in order to provide certainty to the law. Yes, there’s the Canna Provisions case that’s starting to make its way through the federal court system, but even if SCOTUS were to take that case up on final appeal (and that’s a very big if – SCOTUS denies about 99% of all petitions for consideration), that’s years away. I’m not saying that this 10th Circuit case, if it went the right way (or, well, the wrong way, depending on how you look at it), has a better chance of being accepted for review by SCOTUS, but, oy, would we here at Cannabis Musings have a field day if that were to happen.
Be seeing you!
© 2024 Marc Hauser and Hauser Advisory. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form.