Draft Regs: Potential Issues Related to "Ownership"

 

The proposed medical cannabis regulations released by California’s medical cannabis regulatory agencies — the Bureau of Medical Cannabis Regulation (BMCR), the Department of Food and Agriculture (CDFA), and the Department of Public Health (CDPH) — would require licensees to submit a new application any time there is a change in ownership or organizational structure.

This is potentially problematic for cannabis companies for two reasons. First, the definition of “owner” is very broad, and it includes the following: 

For public companies, an owner is anyone holding 5% or more interest in the company.
For private companies an owner is any of the following:
Someone holding an aggregate ownership interest (other than a security interest, lien, or encumbrance) of 20% or more interest in the cannabis business;
The CEO and all members of the board of directors of any entity that holds an aggregate ownership interest of 20% or more in the cannabis business; or
Any other person who participates in the direction, control or management of the commercial cannabis business.

(BMCR § 5004; similar provisions are contained in CDFA’s and CDPH’s proposed regulations.) All individuals and entities considered to be “owners” must disclose personal and financial information about themselves. 

Each individual named on this list shall submit the following information:
(A) The full name of the owner.
(B) The owner’s title within the applicant entity.
(C) The owner’s date of birth and place of birth.
(D) The owner’s social security number or individual taxpayer identification number.
(E) The owner’s home address.
(F) The owner’s telephone number. This may include a number for the owner’s home, business, or mobile telephone.
(G) The owner’s email address.
(H) The date the owner acquired an ownership interest in the applicant entity.
(I) The percentage of the ownership interest held in the applicant entity by the owner.
(J) If applicable, the number of shares in the applicant entity that the owner holds.
(K) Whether the owner has a financial interest in any other licensee under the Act. For purposes of this section “financial interest” means an investment into a commercial cannabis business, a loan provided to a commercial cannabis business, or any other equity interest in a commercial cannabis business.
(L) A copy of the owner’s government-issued identification. Acceptable forms of identification are a document issued by a federal, state, county, or municipal government that includes the name, date of birth, physical description, and picture of the person, such as a driver license.
(M) A detailed description of the owner’s convictions. A conviction within the meaning of this section means a plea or verdict of guilty or a conviction following a plea of nolo contendere. Convictions dismissed under Penal Code section 1203.4 or equivalent non-California law must be disclosed. Juvenile adjudications and traffic infractions under $300 that did not involve alcohol, dangerous drugs, or controlled substances do not need to be included. For each conviction, the owner shall provide the following:
(i) The date of conviction.
(ii) Dates of incarceration if applicable.
(iii) Dates of probation if applicable.
(iv) Dates of parole if applicable.
(v) A detailed description of the offense for which the owner was convicted.
(vi) A statement of rehabilitation for each conviction. The statement of rehabilitation is to be written by the owner and shall contain all evidence that the owner would like the bureau to consider that demonstrates the owner’s fitness for licensure. Supporting evidence may be attached to the statement of rehabilitation and may include, but is not limited to, a certificate of rehabilitation under Penal Code section 4852.01, and dated letters of reference from employers, instructors, or professional counselors that contain valid contact information for the individual providing the reference.
(N) A copy of the owner’s completed application for electronic fingerprint images submitted to the Department of Justice.
(O) Attestation to the following statement: Under penalty of perjury, I hereby declare that the information contained within and submitted with the application is complete, true, and accurate. I understand that a misrepresentation of fact is cause for rejection of this application, denial of the license, or revocation of a license issued.
(P) The following information regarding an individual with a community property interest in the commercial cannabis business under Family Code section 760 shall be provided by the owner:
(i) The full name of the individual.
(ii) The individual’s date of birth and place of birth.
(iii) The individual’s social security number or individual taxpayer identification number.
(iv) The individual’s mailing address.
(v) The individual’s telephone number. This may include a number for the owner’s home, business, or mobile telephone.
(vi) Whether the individual has a financial interest in any other licensee under the Act. For purposes of this section “financial interest” means an investment into a commercial cannabis business, a loan provided to a commercial cannabis business, or any other equity interest in a commercial cannabis business.

(BMCR § 5006; similar provisions are contained in CDFA’s and CDPH’s proposed regulations.) As noted, the draft regulations would require submitting a new license application any time the ownership of a cannabis business changed. It seems excessive to require a new license to be obtained whenever a single individual who may be considered an “owner” is added to or removed from the company. For example, let’s say an LLC held a 25% interest in another company that has a commercial cannabis license. If one member of the LLC’s board of directors changed, then the other company would have to re-apply for an entirely new license to continue operating the way it had been, even though its board may not have changed and even though the LLC still holds a 25% interest.

Second, the requirement that a new application be submitted whenever there is a change in the organizational structure of a commercial cannabis business is troubling. For  years in California, many medical cannabis businesses have structured their entities as nonprofit mutual benefit corporations (MBCs) or nonprofit cooperatives. This is because Senate Bill 420 stated it did not authorize “any individual or group to cultivate or distribute marijuana for profit,” and that qualified patients and primary caregivers who “collectively or cooperatively cultivate cannabis for medical purposes, shall not solely on the basis of that fact be subject to state criminal sanctions under Section 11357, 11358, 11359, 11360, 11366, 11366.5, or 11570.” In 2008, California’s state Attorney General Edmund Brown issued “Guidelines for the Security and Non-Diversion of Marijuana Grown for Medical Use” which talked about statutory cooperatives (agricultural and consumer) and non-statutory collectives as being two types of options for medical cannabis patients and caregivers to “collectively or cooperatively” grow cannabis.

Now, however, the tide has shifted. Under the Medical Cannabis Regulation and Safety Act (MCRSA), a “person” is defined as an individual or corporate entity, and it is implied that medical cannabis businesses may no longer have to operate on a not-for-profit basis under this new regulatory scheme. To clear this up, there is a bill pending in the state legislature, AB64, which would explicitly state that medical cannabis licensees may lawfully operate on a for-profit basis. (AB 64 would do a number of other things as well, such as allow for cannabis-specific state trademarks and place certain restrictions on cannabis advertising.) Thus, the need for nonprofit cooperatives and collectives will be largely gone soon (not to mention the collective and cooperative provision, Health & Safety Code § 11362.775, has a sunset clause which will likely take effect in early January of 2019, 12 months after the state licenses are issued), and many of these existing cannabis companies that are set up as MBCs or statutory cooperatives will likely want to restructure their entity in a way that makes sense for their business. It seems unnecessary and overly burdensome to require a cannabis company to submit a new license application whenever its organizational structure changes, especially since licensees are already required to notify their licensing agency when there is a change in any item listed in the application, which would include the list of owners and entity structure.

This could also create problems between local jurisdictions and the state. If the state requires one to obtain a new license every time ownership changes, then the local permit that was issued to the company before its change in ownership may no longer be valid, triggering the need to go back and get a new local permit as well. However, a local jurisdiction may not be issuing any new cannabis permits, meaning the company that previously had a local permit and state license would suddenly be without a valid local permit or authorization, simply due to what could be a minor change in ownership or entity structure.

Additionally, the proposed regulations explicitly do not allow for the transfer of licenses, and the requirement that a new license be obtained whenever there is a change in ownership or organizational structure effectively prohibits the transfer of licenses as well. For example, let’s say Dispensary A is licensed. Mr. B wants to buy Dispensary A, because he wants a licensed dispensary. Mr. B makes the arrangements and buys Dispensary A, but Dispensary A’s license becomes invalid as soon as the transaction is complete since there is now a new owner who must apply for a new license. This is likely not how most investors and operators in the cannabis industry envisioned an industry-friendly license transfer process.

If you have concerns with any of the proposed regulations, please make sure your comments are submitted by 5:00pm on June 13/14/20 (depending on which license type), 2017. Information about submitting a public comment can be found here: BMCR, CDPH, CDFA. You can comment in writing or in person at one of the scheduled public hearings.

 

The above information is for informational purposes only, may become outdated, and is not intended as legal advice.  Please consult with a lawyer for legal counsel.  Please contact the Law Offices of Omar Figueroa if you have questions about the regulatory process or would like the assistance of counsel in advocating for changes to the proposed regulations.