Cannabis: A Business Opportunity for Those with an Appetite for Risk

September 26, 2019 | Robert C. Kern, Jr. | Matthew V. Spero | Marc S. Ullman | Mark J. Wagner Jr. | Compliance, Investigations & White Collar | Corporate | Health Services

In the past 10 years, the legalization of marijuana and other cannabis-related products have expanded tremendously throughout the United States. Currently, medical marijuana is legal in 33 states and the District of Columbia, while 11 states and the District of Columbia have legalized recreational marijuana use for adults 21 and over.

Additionally, cannabidiol (CBD) got a bump from the 2018 Farm Bill, making it legal to farm hemp (from which CBD can be derived). While CBD is believed to possess various health benefits and is the subject of a drug approval for the treatment of certain childhood seizure disorders, the Farm Bill only removed the Drug Enforcement Administration (DEA) as an obstacle to market; significant Food and Drug Administration (FDA) issues remain.

Risk-tolerant investors and entrepreneurs have chosen to seize the moment, opting to start, operate and/or invest in a marijuana- or CBD-related business. Often they do so without understanding the laws governing the business and the consequences of such an investment. The following is a discussion of the legal considerations to bear in mind before starting or investing in a marijuana or CBD-related business.

Marijuana

Regulations

The Controlled Substances Act of 1970 categorizes marijuana as a Class 1 Controlled Substance, making it a crime to use, sell or cultivate marijuana. While a number of states have decriminalized marijuana, federal law supersedes state law, making it illegal, for example, to transport marijuana in any form across state lines.

In addition, states that have legalized medical and/or recreational marijuana vary in how they regulate the industry. States have different licensure requirements, use restrictions and municipality opt-outs, just to name a few areas of potential variability. In fact, states that have legalized medical marijuana even differ on what constitutes as “medical” marijuana. Notably, these states have separate rules governing medical conditions for which marijuana may be prescribed, limitations on dispensaries, dosage forms, etc. Due to the lack of uniformity among states, it is crucial that you know the applicable rules and regulations governing your potential marijuana-related business to ensure proper formation, operation and investment. You should also be cognizant of the regulatory differences from state-to-state if you plan on operating a marijuana-related business in multiple states.

Banking

Since marijuana is illegal under federal law, any financial institution that handles money from a marijuana-related business can be charged with money-laundering. Because of this, the vast majority of banks and other financial institutions have refused to provide banking services to these businesses. As a result, the industry is forced to operate without bank accounts, credit card payments and the security of electronic transactions.

While the marijuana industry has used alternatives to cash, such as crypto-currency and cash-less technology systems, these are not the norm. Based on the financial industry’s uncertainty, marijuana-related businesses are frequently forced to deal strictly in cash, which presents a host of operational issues, including security, accounting and tracking, payroll and logistics, among others.

Additionally, marijuana-related businesses must be creative in order to obtain financing. Some are strategic in how they structure their corporate entities, while others seek private placements for capital infusions. Yet, some are not willing to give up any equity and seek high-interest loans from private wealth management firms. These options are all very expensive to these businesses.

However, the climate appears to be changing. In 2014, the Financial Crimes Enforcement Network issued guidance to assist financial institutions in providing services to marijuana-related businesses. The guidance stated that as long as the business followed state law and anti-money-laundering procedures, there is a low risk that the business would be prosecuted for criminal money-laundering and money-transmitting. Also, in March 2019, the Secure and Fair Enforcement (SAFE) Banking Act was introduced. The Act, as proposed, would, among other things, prevent federal banking regulators from punishing financial institutions for servicing marijuana-related businesses that are legal under state law. The Act would also protect financial institutions from being charged with money laundering or other financial crimes as a result of their relationship with the marijuana industry. The Act has passed in the House of Representatives, but its ability to gain approval in the Senate is in question.

Bankruptcy

If a business cannot turn a profit and can no longer pay its suppliers or employees, it usually can avail itself of the protections offered by the federal Bankruptcy Code to reorganize, liquidate or get relief from its debt. Although a marijuana-related business may be legal under state law, bankruptcy is not an option. Investors and entrepreneurs should bear this in mind.

Federal legislation introduced to Congress in July 2019 is an attempt to legalize and tax marijuana at the federal level, which may open the bankruptcy avenue to marijuana businesses, but it is too early to predict the outcome of the bill.

CBD

Regulations

The 2018 Farm Bill removed hemp from the Controlled Substances Act, allowing it to be cultivated legally in all 50 states, while remaining subject to state regulation. CBD derived from marijuana is illegal since marijuana remains illegal at the federal level. As a result, any company considering entering the CBD trade must make understanding the sourcing of its raw material its top priority.

Although hemp has been removed from the DEA’s bailiwick, CBD production and incorporation into food products, dietary supplements and medicinal remedies raises FDA concerns. In addition, marketing CBD products with claims that it provides any sort of benefit will be subject to Federal Trade Commission restrictions on unsubstantiated advertising claims.

The fact that the FDA has approved CBD in the form of the drug Epidiolex, for use as a childhood epilepsy medication, constitutes the single largest hurdle for legal introduction into the consumer market as the Federal Food Drug and Cosmetic Act prohibits the use of a substance first approved as a drug in food or dietary supplements. To date, while the FDA has only taken formal action against CBD products that make unapproved drug claims, the Agency continues to take the position that CBD is not a lawful ingredient in food and supplements. As a result, even though hemp derived CBD may no longer be subject to DEA enforcement actions that have made banking and bankruptcy issues a serious concern for marijuana related business, many of the same issues are being implicated by FDA’s position of illegality. However, the National Credit Union Administration recently issued interim guidance allowing credit unions to provide banking services to hemp businesses, including businesses selling CBD products derived from hemp.

Additionally, New York seems to have a favorable outlook on hemp-derived CBD products by passing legislation to establish a regulatory framework for hemp and hemp extracts, including CBD. As of the date of this primer, this legislation has not yet been delivered to the governor for his approval or veto. If signed by the governor, this legislation would provide the Department of Agriculture and Markets with the authority to regulate licensure and permitting, packaging and labeling, and research. Notably, the legislation provides preferential treatment to New York-based hemp by permitting the sale of CBD infused products for human and/or animal consumption only if the hemp extract was grown, extracted and manufactured in New York State while prohibiting the sale of out-of-state hemp extract intended for human and/or animal consumption, unless the product satisfies New York State’s standards. With millions of revenue dollars in the balance, this legislation will play a significant role in structuring the hemp industry in New York State.

Outlook

The marijuana industry presents unique legal and operational risks. However, those business owners and investors who are flexible and creative may reap the biggest rewards in this fast-evolving industry. Those who desire a more stable business or investment, but still want to be in the cannabis market, have turned to CBD, which still has its own unique challenges to overcome.

Rivkin Radler LLP has a number of attorneys with expertise in marijuana- and CBD-related laws governing investment, licensure, and compliance. If you are considering starting a marijuana- or CBD-related business or investing in one, please contact us so that we may help guide you through the process and keep you informed about new developments.

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