I am honored to be quoted in Marijuana Business Daily’s article “Contract cannabis farming gaining popularity in California, but practice draws lawsuits,” discussing the various ways folks can lawfully structure their businesses to meet the needs of a volatile cannabis market. Since the topic appears to be hot, an overview of the legal logistics might be helpful.
First, the article referenced “sharecropping,” a type of agreement popularized during the Reconstruction Era (i.e. post-slavery) where predominantly Black farmers were rent-owing tenants. The landowner was able to unilaterally demand “agreements” wherein farmers received a share of the crops rather than a share of the profits, and would become indebted to the landowner if the yield was less than the rent. In that way, sharecropping was an early and brutal form of ensuring the systemic oppression of Black farmers after slavery.
Today, however, the “bargaining power” between landowner and a potential contract farmer are often quite the opposite. Indeed, farmers in the hills were first to run out of cash due to the exorbitant land-use costs associated with legalization, causing the downstream bankrupting of entire communities throughout rural California. Unlike land barons of the Reconstruction south, Northern California’s rural landowners were the first to be thrown to the land-use wolves while venture-capital backed conglomerates swept up swaths of land in the Central Coast and Central Valley where land-use quagmires were reduced or negated entirely.
Of course, market volatility and our industry’s dangerous penchant for handshake deals make these agreements inherently vulnerable to predation by the party with greater bargaining power. Thus, the deal MUST be in writing, and the compliance issues (regulatory, labor law, etc.) must be fully thought through. Here’s a few legal issues to keep in mind:
1. California Law Expressly Allows Cannabis to be a Lawful Subject of a Contract.
We start the analysis from the premise that cannabis is a lawful subject of a contract. (Cal. Civl. Code §1550.5.) This law opened the floodgates for cannabis businesses to engage in lawful business, including any number of relationships framed by the economics of a transaction. However, with great opportunity comes great responsibility, and these deals are now subjected to all applicable laws, most notably California’s stringent labor laws. More about that below.
2. All Deals Must Be Strictly Compliant or the Deal Is Off.
The regulatory analysis is simple: the deal is compliant or the deal doesn’t happen. Thankfully maintaining strict compliance is not rocket science, as the parties must simply disclose their relationship in whatever manner is required. In the recent Caliva v. Toast Holdings et al., trial court case out of Santa Clara (the first case that I am aware of that discusses the regulatory disclosure requirements in a civil action), the court relied on BCC “Guidance” to note that licensed cannabis businesses may contract with unlicensed businesses in certain circumstances. (P. 10.) However:
“The unlicensed business is not permitted to share in any royalties or a percentage of profits or revenue of the licensee unless disclosed as an owner or financial interest holder of the license.” (Caliva v. Toast Holdings Inc. et al., Order Granting Plaintiff’s Preliminary Injunction. March 5, 2020. Santa Clara Sup. Ct., No. 19CV343016.)
This ruling is consistent with the white labeling analysis provided by the BCC in 2019, which states:
“The Bureau has learned that some licensees may be conducting commercial cannabis business at the direction of non-licensees who may be considered to have an ownership or financial interest in the commercial business and should thus be reported in accordance with sections 5003 and 5004 of the regulations.” (FSOR, p. 19.)
Again, it’s not rocket science: just disclose and move on, or don’t do the deal.
3. These Deals Require Significant Due Diligence.
As the litigation matters discussed in the MJ Biz Daily article make clear, pernicious (often venture-capital backed) license holders may prey on legacy farmers who did not have access to licensure. Check out our prior blog called “Snakes in the Grass: Due Diligence and the Proper Vetting of Potential Deals” for more about how to reduce risk by choosing someone trustworthy to do business with.
At the risk of redundancy, if the other party refuses to disclose or be disclosed during your due diligence discussions, drop it like it’s hot and find another deal, or be at risk for the types of worst-case scenarios discussed in the MJ Biz article.
4. These Deals Are Subject to Labor and Employment Law.
In the Old World, a worker who was to be paid at the end of the season was vulnerable to getting ripped off by disgruntled property owners who could blame a low yield on the worker. Thankfully, this wage-theft is almost impossible in the New World, since non-owners are almost always considered employees entitled to the sweeping protections of California’s employee-friendly laws. We view this as a GOOD THING because it protects laborers from being preyed upon.
The party performing the labor cannot be deemed an independent contractor unless the rules of AB-5 apply, and misclassification is grossly unwise. However, some folks prefer employee status for various reasons, including mitigating or negating “products liability” and “joint and several liability” which may apply to an independent contractor or sweat equity employee, depending on the circumstances.
Thankfully the other half of our law firm is an employment law guru, Sarah Smale, so stay tuned for a detailed blog on Farm Labor Contractors (“FLCs”) in the cannabis farming context that is due out soon.
5. Thinking Through Insurance and Risk Allocation is Critical.
An additional layer of complexity relates to insurance and workers comp issues, since an independent contract laborer hired by a licensee may have trouble getting cannabis-specific workers comp. However, while dual employer liability cannot be waived by contract, those risks and liabilities can be shifted via indemnity clauses and related risk allocations.
Additionally, each party obtaining their own insurance policies could cause a battle of insurance companies, should third-party liability arise. Instead, the existing policy holder can usually add the other as an “additional insured” and reduce risk of contentious dispute.
If structured appropriately, contract farming arrangements can provide a lifeline to struggling farmers by allowing landowners to meet the overwhelming demands of the regulated system, and by allowing a legacy farmer to get their foot in the regulated door. And our industry needs more legacy farmers in the marketplace, that is for damn sure, so creative (but strictly compliant) contracts should not be overlooked as a means to the ultimate end of rebuilding a thriving cannabis agricultural ecosystem for our rural regions.