In the first few years of regulated cannabis activity in California, many (if not most) cannabis farmers did not get paid for their product on time and, in some cases, they didn’t get paid at all. Debt collection quickly became a hot topic, as unpaid farmers waded through their legal options, from selling the debt to full tilt civil litigation. In those situations, a written contract almost always helps the farmer, which means oral agreements often hurt the producer (aka the farmer) more than the buyer (aka the distributor or manufacturer). To be sure, the best defense is a good offense (just sayin’).
While we are hoping to see more on-time payments this year, here’s a quick reminder of the debt-collection issues in play for the 2020 harvest season just in case:
1. Private Debt Collectors
There are a few private companies who will buy or assume a farmer’s outstanding debt, oftentimes at pennies on the dollar. Although there are lots of ads for these companies on the internet, we’ve not yet heard of a debt collection company actually getting a farmer their money in the California cannabis farming context, but our fingers are crossed that this method becomes more viable in the future.
If a farmer decides to go with a private debt collection company, it’s important to keep the statute of limitation in mind, so it’s wise to check with an attorney regarding how much time to give the debt collector to collect.
2. A Demand Letter
A “demand letter” is a letter demanding that someone pay a debt as agreed, and this is often the first step in more aggressively going after an unpaid debt. A demand letter does not necessarily need to be written by an attorney, though a formal demand is often a legal requirement before suing someone, yet they also might used as evidence down the road. That’s why demand letters should be prepared with the nuanced case-specific legal issues in mind.
Demand letters can do more harm than good if they are sloppy, admit a weakness in the case, or disclose a legal strategy too soon. Be wary of sending out demand letters without properly vetting the legal issues and the legal strategy, including avoiding making any damaging admissions. Consider sending the demand letter confidentially, pursuant to California’s strong public policy in favor of private settlements of disputes. See California Evidence Code Section 1152 and consider adding this statement to the beginning of your demand letter: “The following is a confidential settlement communication pursuant to California Evidence Code Section 1152. Offers of compromise in settlement negotiations are inadmissible to prove liability for loss or damage.”
3 . Alternative Dispute Resolution
Sometimes folks who are disputing a debt are willing to go to mediation or arbitration to keep the dispute out of court. Alternative dispute resolution (ADR) procedures such as mediation and arbitration are most helpful where there is some disagreement about the outstanding payment, such as who is responsible for a product that fails testing after a distributor fails to quarantine the product appropriately. Mediation is never binding; it is simply the use of an experienced neutral to help the parties reach a compromise. Arbitration can be binding or non-binding and takes the place of a court trial. In both mediation and arbitration, both parties have to agree to participate (though in certain cases with respect to arbitration, a party could be compelled to arbitrate based on a contract clause, for example).
However, ADR is less helpful if the buyer is simply ignoring the seller (aka “radio silence”) or is going out of business (which is unfortunately common in California cannabis), since ADR is most effective when both parties are engaged in the process.
4. Breach of Contract Lawsuit
If a demand goes unanswered, the next step may be to institute a legal case, a.k.a. litigation. If the farmer takes the buyer to court, the primary “causes of action” or “claims” would likely be related to breach of the agreement to pay money to the farmer for their product and that buyer’s unjust enrichment off of the farmer’s product.
Many farmers “eat” their losses and instead choose not to sue because litigation is costly, stressful, and time consuming, but keep in mind that attorneys’ fees are often in play in breach of contract actions, meaning the party that wins the lawsuit may be able to have their attorneys’ fees added to the other side’s bill. In oral agreements, there is almost never an enforceable agreement for attorneys’ fees- another point in favor of always using a professionally written contract.
5. Foreclosing on a Security Interest or Producer’s Lien
A security interest is simply collateral from one party to another for an unpaid debt. Security interests can take many forms but the main point is that the farmer (who holds the security interest) may be able to get paid out on a priority basis if the buyer goes out of business and ends up selling off its assets. We often recommend security interests wherever the sells their entire season in a single transaction under an agreement to pay the farmer at some later date.
In addition to security interests granted in a written purchase agreement, California law thankfully offers farmers an “producer’s lien,” which is a special type of security interest that farmers keep in their product after a buyer takes possession of the product before paying. A producer’s lien is an implied security interest, meaning the parties do not need to have a written contract in place for the lien to exist: it is automatic, provided they do not waive the producer’s lien in any written agreement.
While CDFA does offer an administrative avenue for foreclosing on a producer’s lien, cannabis farmers are not yet eligible to use that option. This means that cannabis farmers can only foreclose their producer’s lien in a civil court at this time. There is no precedent (as far as we’re aware) applying the producer’s lien in the cannabis context, though the law is fairly clear, so we assume this lien will be applied in the cannabis context at some point in the future.
Additionally, the producer’s lien may be extinguished if the buyer sells the product to a third-party, as is often the case with cannabis distributors who are acting as an intermediary (aka middle-man/broker). In such a case, the farmer may want to consider filing an injunction to stop the distributor from selling the cannabis to another party.
Moving forward, we hope written security interests become more common in California’s cannabis purchase agreements, since they offer the farmer the most protection. If a distro or manufacturer is taking the farmer’s entire season in a single transaction without paying at the time of delivery, security interests are a fair request.
In closing, these are worst case scenarios that generally only come into play when the farmer is already under financial stress due to the lack of payment. So the processes for going after an unpaid debt are often shrouded in a cloud of negativity and are not utilized. However, these formal processes are designed to protect sellers from unscrupulous buyers, meaning these systems may suck, but they can be powerful tools to protect farmers from getting ripped off.
Use of a written contract with an attorneys’ fees clause will provide the most protection in the event of non-payment, as the attorneys’ fees clause makes it harder for the buyer to justify the cost of the fight if the case were to proceed through trial and result in a prevailing party attorneys’ fee award. If all of this information is making your head spin, reach out to an attorney knowledgeable about the California cannabis industry and breach of contract actions.
Massive gratitude to Katy M. Young of Ad Astra Law Group LPP in San Francisco, one of Sarah and my favorite civil litigators of all time, for co-authoring this blog with me. Stay safe please!
Heather Burke (Origin Group Law LLP)
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Katy M. Young, Ad Astra Law Group LLP
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