Cannabis Musings - August 15, 2024

The illegality defense is the gift that keeps on giving.

Friends, long-time readers of these Cannabis Musings will know that one of my favorite stories is when someone claims their contract can’t be enforced because cannabis is illegal.  It doesn’t get much funnier than that in law, and must be appreciated for the naked chutzpah it takes to make the argument in the first place. 

We talked about one of these cases back in April – the appeal of a federal trial court decision in a dispute over an ownership agreement between investors in a Colorado-based, plant-touching cannabis operator.  As I explained, the appellate court faced the question of:

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.

In other words:

“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? … Where in that liminal space do we draw the line?”

In a gambit to make this even funnier, in late July, the 10^th Circuit Court of Appeals punted.  You can read the opinion in all of its extensively-footnoted glory, but, basically, the majority of the three-judge appellate panel simply couldn’t decide whether the trial court judge’s order “effectively ordered Mackie and Trellis to violate federal drug law.”  In other words the appellate court wasn’t sure whether a forced sale of equity “may effectively require” a continued violation of the Controlled Substances Act.  Sure, the act of selling the equity itself doesn’t involve cannabis, but the underlying, very illegal business still remains in operation.

The dissenting judge didn’t buy it: “this Court should acknowledge the elephant in the room,” that (i) the company produces cannabis and (ii) that’s illegal, so (iii) no.  It’s the “Really, I mean, really? Come on.” argument.  And yet, dissents don’t really matter, particularly at the appellate court level.  So, there we are.

Reading between the lines, I think what’s happening here is that the appellate court is trying to find a way to support the trial court judge’s order, and resolve the dispute, by acknowledging the illegality problem, and yet suggesting that the judge find that, as a matter of fact, no federal law is being broken.  In other words, they want the judge to say: “oh, no, they’re definitely not breaking federal law [winking emoji] … .” 

So, sadly, we’re not going to get the clarity that we were hoping for, but illegality remains a real threat in federal court.

It also happens to be a problem in Texas.  Law360 reports that a Texas state appellate court recently upheld an illegality defense in another contract dispute over payment for a cannabis cultivation operation in Oregon.  Back in 2017 (the wheels of justice turn slowly), the plaintiff and the defendant agreed to an oral contract to start a cannabis farm in Oregon that “was to become ‘an empire.’”  You have to admire the ambition. 

Needless to say, payments weren’t made and litigation ensued.  The defendant, whose lawyer clearly has a sense of humor, argued that payments couldn’t be enforced because cannabis is illegal.  Now, for some reason, the plaintiff sued in Texas court, a state that doesn’t allow adult-use cannabis.  If they had sued in Oregon, the illegality defense likely wouldn’t have gotten very far – that state, like others (but not Texas), has a law that says that contracts aren’t unenforceable just because cannabis is illegal under federal law.  Those laws are on the books for this very reason.  (The opinion briefly delves into whether Oregon, Texas, or federal law applied, but it looks like the plaintiff conceded Texas law.)

The appellate court found that, indeed, the contract was for services that are illegal under federal law, and so that contract can’t be enforced (even though the cannabis grow was in Oregon, where adult-use cannabis is legal).  Interestingly, the court dropped a lot of ink musing on the difference between medical and adult-use cannabis.  Although it refused to draw any actual conclusions, it suggested that it might have found differently if the case involved medical cannabis, pointing to Texas’ own, limited medical cannabis laws, as well as some distinction at the federal level.

The takeaway from all of this is that, if you’re going to sue to enforce a cannabis contract, don’t sue in federal court - sue in a state where the laws say “nope” to the illegality defense.  Or do otherwise and continue to provide me with amusement.

One last thing to note - the Texas court fairly easily swatted down arguments that federal policy towards cannabis has eased over the years, not buying that the (long rescinded) Cole Memo, Rohrbacher-Farr, and the 2023 Biden pardons mean that federal law is somehow ambiguous.  Recall that the Canna Provisions lawsuit – the one that essentially requires the US Supreme Court to overturn existing precedent in order to allow for legal intrastate cannabis commerce – is similarly a policy argument about federal attitudes towards cannabis.  Now, it’s admittedly a stretch to suggest that a Texas appellate court decision is a bellwether for federal appellate courts, but it’s worth noting that conclusion here.

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.  The foregoing represents my own views and not those of Jardín.