[co-author: Natalie S. Starkman]

NY-state-logo-300x158Although cannabis is still classified as a controlled substance at the federal level, New York State recently enacted the Marijuana Revenue and Taxation Act (MRTA), a law legalizing adult-use cannabis within the state. Questions abound, however. When will all five members of the Cannabis Control Board be appointed? When will the Board, once appointed, establish regulations including with regards to the licensing and application process—and what kinds of licenses will be available? Practically speaking, will landlords be willing to take on the risk of leasing space to cannabis cultivators, processors or dispensaries—and, if so, what are some of the issues that will arise in negotiating leases to cannabis operators? What constraints does the MRTA place on the location of these businesses?

Licensing Considerations for Adult-Use Cannabis Operators in New York
New York’s Marijuana Revenue and Taxation Act, legislation legalizing recreational-use cannabis, was enacted in March 2021 and creates a new Cannabis Law as Chapter 7-A of the Consolidated Laws of New York. The legislation delegates to the Board and a new Office of Cannabis Management (OCM) the authority to create and enforce a regulatory framework governing medical and recreational/adult-use marijuana. The five-member board will consist of three members appointed by the governor, one appointed by the state Senate, and one appointed by State Assembly. The Board must adopt regulations before the licensing process can begin. Although efforts to appoint the Board stalled following enactment of MRTA, Gov. Kathy Hochul recently appointed, and the Senate confirmed, leaders of both the Board and OCM. Tremaine Wright, a former member of the New York State Assembly and currently the first Director of the Department of Financial Services’ Statewide Office of Financial Inclusion and Empowerment, will lead the Board. Christopher Alexander, a criminal justice reformer and former legislative aide in Congress and the New York State Senate who was a lead drafter of MRTA, will serve as Executive Director of OCM. As membership of the Board and OCM take shape, potential applicants should be preparing to meet MRTA’s unique licensing requirements.

The MRTA includes many provisions intended to address issues involving social and economic equity, with a particular focus on people and communities that have been impacted by criminal enforcement of cannabis laws. In fact, it may be more focused on these issues than any other state’s legislation that legalizes cannabis. The legislation directs the Board and OCM to prioritize applications from social and economic equity applicants—which the MRTA defines as individuals from communities that have been disproportionally impacted by the criminalization of cannabis, minority- and women-owned businesses, distressed farmers, and service-disabled veterans. MRTA also includes a process through which social and economic equity applicants can receive additional support to establish licensed cannabis operations, including through loans, grants, and incubator programs. These measures are intended to help meet MRTA’s stated goal of issuing 50% of licenses to social and economic equity applicants. The legislation also directs the Board and OCM to appoint a chief equity officer and to develop a plan to promote applications from social and economic equity applicants. Social equity licensees will be prohibited from selling or transferring their licenses within the first three years after issuance, except to other qualified social equity applicants.

Applicants who do not qualify as social or economic equity applicants should be considering how their operations might meet the policy goals of MRTA, because the legislation’s licensing framework includes several criteria focused on social and economic equity. Among the factors that the Board and OCM will consider in granting licenses is whether the applicant has a plan for benefitting communities and people disproportionately impacted by cannabis enforcement, and licensees will have to submit evidence of how they carry out those plans (in fact) in license renewal applications. What constitutes a community that has been disproportionately impacted by cannabis enforcement is not precisely defined in the MRTA; it is likely that the Board will further define this term through regulations. Applicants for licenses will also be evaluated based on how they minimize environmental impacts in the course of conducting their business.

The adult-use portions of the MRTA create a licensing structure that prohibits “vertical” integration in most cases. This means that operators who cultivate, process, or distribute cannabis generally will not be permitted to also have a direct or indirect interest in retail dispensaries, including through ownership, common directors, management agreements, or real or personal property interests. This differs from New York’s existing medical marijuana program, in which a small number of vertically integrated registered organizations (“Registered Organizations”) hold licenses.

Existing medical marijuana operators will be able to enter the recreational market by distributing their product to dispensaries, or by paying a one-time “special licensing fee” to open or convert up to three dispensaries to dual medical-recreational stores—with such fees being applied to fund social equity programs, consistent with the statute’s stated goals.

Types of Licenses
The MRTA authorizes several different license types, each of which allow licensees to provide a defined list of services. The initial licenses will expire two years after issuance. There are express restrictions on having multiple licenses, which as noted above has the general effect of prohibiting vertically integrated cannabis businesses. While not all licenses have explicit, related real property prerequisites (which will be further addressed below), many do and applicants will need to “plan for” a real estate transaction in connection with any license application.

The various available licenses—and restrictions that apply to such licenses—are identified in the following chart:

Available Adult-Use Cannabis Licenses

Real Estate a Prerequisite
While the distributor and on-site consumption license requirements are the most stringent in that they require the prospective licensee to demonstrate a real estate “interest,” the MRTA ostensibly requires a real estate “interest” for many of the available licenses. Section 64(e) of the MRTA, for example, generally requires that “where appropriate and applicable, the applicant possesses or has the right to use sufficient land, buildings, and equipment to properly carry on the activity described in the application or has a plan to do so if qualifying as a social and economic equity applicant”—while Sections 72 and 77 of the MRTA explicitly require that businesses applying for retail dispensary and on-site consumption licenses must demonstrate possession of such an interest within 30 days of final approval of a license. We do not expect that an option to lease will suffice for these purposes. Those sections of the MRTA that apply to businesses which would operate out of a specific physical location (basically, all but delivery services) refer to the “licensed premises,” and Section 67 of the MRTA provides that licenses issued pursuant to the law must specify the land, building and facilities that may be used for the “licensed activities of the licensee.” Section 67(2) goes on to allow for amendment of the application to allow the licensee to relocate within the state, but Section 67(3) further provides that a license issued shall become void after a change in location without the prior written approval of the Board. Prospective licensees will want to choose their business location(s) thoughtfully, in the event a future relocation may be denied by the Board.

Note that, the “opt-out” provisions granted to municipalities in the MRTA will have “closed” by January 1, 2022—so that the list of those municipalities that will allow cannabis businesses (and those that will not) will be clearly established as of such date.

Real Estate-Related Issues and Considerations for Landlords and Tenants
Landlords leasing or considering leasing land or space to an adult-use cannabis operator are likely to proceed “with caution.” In this regard, we note (i) that Landlords will need to work closely with their lenders in connection with entering into any such lease and (ii) the existence of the federal statute commonly known as the “Crack House Statute” [21 USC §856(a)(1)] which allows federal authorities to enter businesses and charge those involved with forfeiture proceedings and which specifies that knowingly opening, leasing, renting, using or maintaining any place for the purpose of manufacturing, distributing or using any controlled substance constitutes a felony. Landlords leasing to businesses under valid licenses issued by New York State will operate in what is still a “gray area,” arguably running the risk of forfeiture of the leased premises to the federal government and criminal prosecution along with the tenant business (and imprisonment and fines if convicted) under the federal law. The prioritization of such prosecution, particularly in jurisdictions with laws allowing for marijuana use, has become politicized in recent years, leaving landlords with contradictory guidance on the issue. At a minimum, landlords should critically review potential leases to confirm boilerplate language that a tenant comply with federal, state and local laws. Landlords should additionally consider additional terms as well, addressed further below.

The following is a list of issues and considerations that are likely to (or may) arise in the context of a lease negotiation with a cannabis operator, as tenant.

  • Clearly, one of the first Lease provisions that the Landlord will want to revisit and possibly expand is the provision regarding Tenant’s obligation to comply with all applicable laws, licenses and permits. Specific references to all applicable laws, and the MRTA and accompanying regulations, should be made. Landlord will also want to add an acknowledgement by the Tenant to the effect that it understands that cannabis remains illegal at the federal level.
  • Landlords will want to have generous inspection rights—if for no other reason than to confirm compliance with laws, to the extent possible.
  • Of course, the permitted use provisions of the Lease will need to accurately reflect the intended use, as permitted under law and the Tenant’s license. In this regard, Tenants may request that Landlords cooperate in the licensing or licensure renewal process, as required by the statute.
  • Landlords will want to consider including generous termination rights—as will Tenants should, for example, Tenant’s fail to obtain a license or license renewal (among other reasons). Other grounds for termination might include changes in law, or seizure by any law enforcement agency.
  • Landlords will want to consider including specific and possibly immediate and automatic defaults should the Tenant fail to comply with laws or its license.
  • Landlords will want to pass all “increased” costs along to Tenants—such as water or electricity costs, garbage or waste storage expenses, or increased “security” costs resulting from the nature of the tenant’s operations—and all parties may benefit from separate metering and a clear articulation (and allocation) of any such costs.
  • Landlords will want to clearly articulate the obligations of Tenants to remove fixtures and improvements upon any surrender or lease termination (as desired)—and should be wary of (or anticipate, to the extent possible) sudden abandonment of the premises by the Tenant(s).
  • Landlords will need to consider how and whether to structure rent so as to include percentage rent. A question that will likely arise for Landlords, in this context, is whether the collection of percentage rent “makes the Landlord a partner” with the Tenant—whether such “profit-sharing” violates federal law and, possibly, any of Landlord’s loan documents.
  • Landlords will need to carefully analyze and consider the identity and credit of the Tenant and its “sponsor” and owners—as a general matter, of course—and particularly also in the context of analyzing the benefit of any indemnities or guaranties in such a Lease (and presenting such a tenancy to Landlord’s lenders, as applicable). Of course, the scope of any indemnities will need to be carefully reviewed and possibly expanded.
  • Landlords will need to pay particular attention to Tenant’s insurance coverage—for example, does the Tenant’s insurance policy cover (i) product liability (and what does that mean, in this context), (ii) personal property (and what does that mean, in this context) and (iii) business income or interruption insurance? A more fulsome discussion of these issues will follow, in a separate Client Alert.
  • Landlords will want to consider obtaining “more” security than would typically be the case—particularly if Tenant has negotiated for early termination rights.
  • As a technical leasing matter, the parties will want to exclude cannabis from the definition or treatment of “Hazardous Substances” in the Lease.

Possibility of Federal Legalization
The U.S. House of Representatives and Senate are considering legislation to federally legalize cannabis. Congress has also considered narrower legislation that would ensure access to financial services for cannabis businesses, and the House passed this legislation, known as the SAFE Act, on April 19, 2021. However, as of the date of this post, the Senate has not moved on the SAFE Act.

Although New York State is not yet granting licenses to adult-use operators, those who intend to apply for licenses should be preparing their business plans and real estate “approaches” and negotiations—along, of course, with raising capital, as needed.

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Published at JD Supra:  https://www.jdsupra.com/legalnews/operating-an-adult-use-cannabis-6232004/