Authors:
Agustin Rodriguez
Christina Sava
Michael Jordan
Residency Rules in Cannabis Industry May Not Withstand Constitutional Scrutiny
Authors: Agustin Rodriguez, Christina Sava, Michael Jordan
There are many unique challenges to consider when opening or investing in a cannabis business. Not least of them are state and local prohibitions or restrictions on the licensure of individual nonresidents or corporate entities owned by such nonresidents. These types of restrictions can trip up even the most sophisticated investors, entrepreneurs, and multistate operators as they try to enter new markets or take advantage of a business opportunity.
In other industries, requirements stating that business licenses be reserved for residents or applicants owned by residents of a certain state are largely a thing of the past. They have been rejected by courts as violations of the dormant commerce clause — a legal doctrine holding that a state law discriminating against out-of-state goods or nonresident economic actors can stand only if it is narrowly tailored to promote a legitimate local purpose.[1] As recently as 2019, this doctrine was invoked to overturn Tennessee’s residency requirement for owners of liquor store licenses. In Tennessee Wine and Spirits Retailers Assn. v Thomas, the Supreme Court held that, although Tennessee did have authority to enact measures addressing the public health and safety effects of alcohol use, the state’s residency requirement for owners of applicants did not actually promote public health or safety.[2] Furthermore, there was no evidence presented that nondiscriminatory alternatives would be insufficient to further the state’s public health or safety interests.[3]
The dormant commerce clause has yet to be applied broadly to the cannabis industry, however. Dozens of states and municipalities have enacted and enforced residency requirements that bar or restrict nonresidents from holding licenses or equity in a licensed entity, and in some cases, even investing in local cannabis businesses. A recent example is New Jersey’s adult use regulatory scheme, which includes a requirement that applicants have at least one owner who has resided in New Jersey for at least two years prior to the date of application,[4] and a provision awarding bonus points for applicants who include at least one owner lawfully residing in New Jersey for at least five years prior to the date of application.[5] Washington state’s longstanding residency requirement provides that a nonresident may not own any stake in a Washington cannabis business,[6] and Virginia’s new adult-use legislation reserves the possibility that the state’s Cannabis Control Board may include some type of residency requirement in its qualifications for owners.[7] Alaska requires that all persons with a direct or indirect financial interest in a cannabis business be Alaska residents,[8] and Massachusetts requires that microbusiness applicants and craft marijuana cooperatives be majority-owned by state residents.[9]
Most of these laws intend to promote local ownership, while also acting as a strategy to minimize federal interference with a state’s (intrastate) cannabis program.[10] Most of the laws have gone unchallenged, and in some cases where they have been challenged, courts have been unwilling to interfere due to marijuana’s federally illegal status. The U.S. District Court for the Western District of Oklahoma, for instance, recently granted the state’s motion to dismiss a challenge to its residency requirements for medical marijuana licenses.[11] The court ignored the dormant commerce clause question and found cannabis’ federal illegality to be dispositive. It agreed with the state that “the court should not use its equitable power to facilitate conduct that is illegal under federal law.”[12] While Oklahoma also may have had “unclean hands” because it enacted the federally-illegal cannabis program in the first place, the court reasoned that, if the residency requirement were overturned, not only would plaintiffs be permitted to engage in federally illegal activity, but the state would also benefit from even more tax revenue if nonresidents were also able to obtain medical cannabis business licenses.[13] Therefore, “granting plaintiff the equitable relief it seeks here would facilitate criminal activity more (by allowing non-residents to have medical marijuana business licenses) than would a denial of equitable relief.”[14]
When courts consider the merits of a dormant commerce clause challenge, however, the protectionist element of such residency requirements is often undeniable. Indeed, preliminary challenges to such rules have recently seen a string of successes. In Missouri, Mark Toigo, a Pennsylvania resident and minority owner of a licensed Missouri marijuana dispensary was prevented from becoming a majority owner of the dispensary by a Missouri law that required dispensaries to be majority-owned by Missouri residents.[15] Toigo sued, and the U.S. District Court for the Western District of Missouri held the law violated his constitutional right to engage in interstate commerce.[16] The court rejected Missouri’s argument that the residency requirement was necessary to prevent the illicit diversion of medical marijuana.[17] Instead, the court found there were non-discriminatory means of promoting these interests, such as requiring applicants and industry workers to undergo criminal background checks, tracking marijuana from seed-to-sale, requiring constant video surveillance of marijuana facilities, and providing government access to business records.[18] Although preventing the illicit diversion of medical marijuana may be a legitimate state interest, the court’s ruling suggests a residency requirement will not be narrowly tailored enough to promote that interest.
In Michigan, a challenge was brought to a Detroit ordinance that gave preferential treatment for adult-use retail licenses to long-term Detroit residents.[19] Specifically, in order to better serve communities affected by the War on Drugs, Detroit gave preference to applicants who had resided in the city for 15 of the past 30 years; resided in Detroit 13 of the past 30 years and met low income requirements; or resided in Detroit 10 of the past 30 years and either had a criminal record related to a controlled substance, or a parent who had such a record while the applicant was a minor.[20] Lowe, an 11-year Detroit resident who did not meet the preferential criteria, challenged the law as a violation of the dormant commerce clause, among other claims.[21] In granting Lowe’s motion for a preliminary injunction, the U.S. District Court for the Eastern District of Michigan observed that the ordinance “do[es] not appear to be rationally related to the stated purpose of rectifying the harm done to City residents by the War on Drugs.”[22] Instead, the ordinance “prefers wealthy applicants who have had no interaction with the War on Drugs to low-income applicants who have been ravaged by it, so long as the wealthy applicants have lived in Detroit for the right amount of time.”[23] The order signals that courts may closely scrutinize social equity initiatives to ensure they are appropriately tailored to achieve their stated goals.[24] Full arguments on the case will take place in 2022.
And, in Portland, ME, a medical marijuana dispensary that was 95%-owned by non-Maine residents and companies, challenged a Portland ordinance that gave preference to Maine residents for allocating adult-use retail licenses.[25] The ordinance created a 34-point grading rubric that awarded five points to applicants that were 51%-owned by Maine residents and four points to applicants owned by certain individuals who have previously been awarded Maine business licenses.[26] After finding that the rubric likely impermissibly discriminated against interstate commerce, the court rejected Portland’s argument that the preference for Mainers was necessary to easily verify past violations, noting that the state’s elaborate vetting process would likely address that concern.[27] Facilitating criminal background checks might be a legitimate state interest, but a residency requirement may not be the least protectionist way to promote that interest. The court granted the dispensary’s motion for a preliminary injunction and, in response, Portland amended its code to remove the provisions. The parties stipulated to dismissal of the case.[28]
Two other notable challenges to residency requirements are worth watching closely, as they may have much broader implications for residency requirements across the U.S.
First, Northeast Patients Group et. al. v. Figueroa, currently before the First Circuit Court of Appeals, is the first challenge to a cannabis residency rule to make it to a circuit court of appeals. As such, it could set a precedent that begins to topple these rules across the country. Plaintiff High Street Capital Partners, a company owned entirely by non-Maine residents, sought to acquire Wellness Connection, a dispensary owned by all-Maine residents.[29] The transaction was prohibited due to Maine’s requirement that all officers or directors of a dispensary be Maine residents.[30] The District Court for the District of Maine disagreed with the state that the U.S. Constitution offered no protection to the plaintiffs because of cannabis’ status as a Schedule I substance under federal law.[31] The court held that Maine’s cannabis program was not wholly intrastate because nonresidents could come into Maine, purchase cannabis, and transport it across state lines;[32] Congress had not clearly authorized states to enact such discriminatory measures;[33] and, in “apparently all cases where federal courts have confronted dormant Commerce Clause challenges to state or local laws that favor residents in the recreational or medical marijuana context, the courts have held that such laws are likely unconstitutional.”[34] Maine has appealed to the First Circuit Court of Appeals,[35] and the state’s appeal brief is due in circuit court on December 20.[36]
Another case to watch is Brinkmeyer v. Washington State Liquor and Cannabis Board, a challenge to Washington state’s residency rules.[37] These rules have frustrated would-be entrants to this major West Coast market since the adult-use program’s inception. Plaintiff Todd Brinkmeyer, an “adviser and financier” to a Washington cannabis business, but a resident of Idaho, took issue with the fact that he is permitted to finance a Washington cannabis business but may not reap profits as an owner of the business. He challenged the state’s residency rules as a violation of the dormant commerce clause, among other constitutional law claims.[38] Brinkmeyer also claimed that the residency requirement violates the privileges and immunities clause in Washington’s state constitution.[39] The Thurston County Superior Court dismissed the state constitutional law claim due to lack of standing: because Brinkmeyer is not a resident of Washington state, the state’s privileges and immunities clause does not apply to him.[40] With respect to the federal constitutional law claims, the Liquor and Cannabis Board removed the case to the District Court for the Western District of Washington, where those claims are now pending. Oral argument is expected sometime in 2022.
Depending on the outcome of the above cases, general residency requirements may not survive constitutional scrutiny. Narrowly-tailored residency requirements, however, especially in the context of social equity, just might.[41] For instance, social equity applicants may have to prove, in addition to other qualifications, that they have been residents of a certain city or state for a certain amount of time prior to submitting an application.[42] Although the court in Lowe v. City of Detroit found that Detroit’s particular program was not sufficiently targeted to its stated goals, it is possible such requirements could be written in such a wayto advance the legitimate goals of the city or state, and therefore withstand constitutional scrutiny. The Supreme Court has observed that even race-conscious criteria in an ordinance seeking to alleviate historic discrimination could survive strict scrutiny where the classifications serve a compelling interest and are narrowly tailored to redress specific harms caused by a city’s specific policies.[43] By way of analogy here, a social equity program’s residency requirement might avoid running afoul of the dormant commerce clause where it gives preference to specific communities that have demonstrably suffered from that government’s specific enforcement of criminal drug laws. Moreover, if residency requirements are challenged in this context, and courts do not uphold them, Congress has the power to give cities and states the authority to pass such laws.[44] Given that social equity programs have become a pillar of cannabis legalization, this may become part of a federal cannabis legalization framework.
This realm of policymaking may reveal a lot. The potential overturn of general residency requirements in the cannabis industry will usher in a new era of expansion for multistate operators, as well as fierce competition for local cannabis businesses that have benefitted from this period of protectionism. As with many things in the evolution of the cannabis industry, it will be a welcome change for some, and an unwelcome challenge for others.
[1] Tenn. Wine & Spirits Retailers Ass’n v Thomas, 139 S. Ct. 2449, 2462 (2019).
[2] Id. at 2474.
[3] Id.
[4] N.J. Admin. Code § 17:30-7.11(a)(4).
[5] Id. § 17:30-7.11(b)(13)(v).
[6] Wash. Admin. Code § 314-55-020(11).
[7] S.B. 1406 § 4.1-809(1)(b), 2021 Sess. (Va. 2021).
[8] Alaska Admin. Code tit. 3, § 306.015(b).
[9] 935 Mass. Code Regs. §§ 500.101(3)(d)(1), 500.101(3)(b)(1)(a).
[10] The U.S. Department of Justice’s Guidance Regarding Marijuana Enforcement, issued August 29, 2013 by then-Deputy Attorney General James M. Cole (known commonly as “The Cole Memorandum,” now rescinded) set out several federal law enforcement priorities with regards to cannabis. States have asserted that residency requirements ensure that the state’s cannabis program does not run afoul of these priorities, particularly “Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;” “Preventing the diversion of marijuana from states where it is legal under state law in some form to other states;” and, “Preventing state-authorized marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal activity.” See U.S. Dep’t of Just., Guidance Regarding Marijuana Enforcement 1–2 (2013), https://www.justice.gov/iso/opa/resources/3052013829132756857467.pdf.
[11] See Original Invs., LLC v. Oklahoma, No. CIV-20-820-F, 2021 U.S. Dist. LEXIS 105320, at *15–16 (W.D. Okla. June 4, 2021).
[12] Id. at *4.
[13] Id. at *8.
[14] Id.
[15] Order Granting Preliminary Injunction at 1, Toigo v. Dep’t of Health & Senior Servs., No. 2:20cv4243 (W.D. Mo. June 21, 2021), ECF No. 25.
[16] See id. at 14; Order Granting Permanent Injunction at 2, Toigo v. Dep’t of Health & Senior Servs, No. 2:20cv4243 (W.D. Mo. Nov. 15, 2021), ECF No. 39 (adopting reasoning of the court’s earlier order on the motion for preliminary injunction).
[17] Order Granting Preliminary Injunction at 7–10, supra note 15.
[18] Id.
[19] Lowe v. City of Detroit, No. 2:21cv10709, 2021 WL 2471476, at *1 (E.D. Mich. June 17, 2021).
[20] Id. at *2.
[21] Id. at *1–2.
[22] Id. at *7.
[23] Id.
[24] The court’s order suggests the ordinance might not only run afoul of the dormant commerce clause, but also the Michigan Constitution’s guarantees of equal protection and right to inter- and intra- state travel. See id. at *7–10.
[25] NPG, LLC v. City of Portland, No. 2:20cv208, 2020 WL 4741913, at *1–3 (D. Me. Aug. 14, 2020).
[26] Id. at *2.
[27] Id. at *11–12.
[28] Stipulation of Dismissal, NPG, LLC v. City of Portland, No. 2:20cv208 (D. Me. Dec. 13, 2020), ECF No. 22.
[29] Ne. Patients Grp. v. Me. Dep’t of Admin. & Fin. Servs., No. 1:20-cv-00468-NT, 2021 U.S. Dist. LEXIS 151027, at *3 (D. Me. Aug. 11, 2021).
[30] Id. at *4.
[31] Id. at *11–12.
[32] Id. at *11.
[33] Id.
[34] Id. at *12.
[35] See Defendant’s Notice of Appeal, Ne. Patients Grp. v. Figueroa, No. 21-1759 (1st Cir. 2021).
[36] See Appellant’s Briefing Notice at 2, Ne. Patients Grp. v. Figueroa, No. 21-1759 (1st Cir. 2021). The district court granted a stay of its own injunction pending the appeal, finding that temporarily allowing out-of-state residents into Maine’s cannabis market could have irreparable harm if the First Circuit ultimately upholds the residency requirement. See Order on Motion for Stay Pending Appeal at 3–6, Ne. Patients Grp. v. Me. Dep’t of Admin. & Fin. Servs., No. 1:20-cv-00468-NT, 2021 U.S. Dist. LEXIS 207316, at *6 (D. Me. Oct. 27, 2021), ECF No. 41.
[37] See Brinkmeyer v. Wash. State Liquor & Cannabis Bd., No. 3:20cv5661 (W.D. Wash. 2021).
[38] Petition for Declaratory Judgment ¶¶ 30–57, Brinkmeyer v. Wash. State Liquor & Cannabis Bd., No. 20-2-01568-34 (Wash. Super. Ct. June 8, 2020).
[39] Id. ¶¶ 58–62.
[40] Order Granting Summary Judgment to the Board and Denying Plaintiff’s Motion for Summary Judgment, Brinkmeyer v. Wash. State Liquor & Cannabis Bd., No. 20-2-01568-34 (Wash. Super. Ct. July 23, 2021).
[41] These are state and local programs which reserve cannabis licenses for, or give special advantages to, applicants who can prove they have been impacted by the War on Drugs.
[42] See, e.g., Va. Code Ann. § 4.1-606(B)(13) (“The Board shall promulgate regulations that…[e]stablish criteria by which to evaluate social equity license applicants, which shall be an applicant who has lived or been domiciled for at least 12 months in the Commonwealth and [meets additional criteria] . . . .”).
[43] See City of Richmond v. J.A. Croson Co., 488 U.S. 469 (1989) (“States and their subdivisions may take remedial action when they possess evidence that their own spending practices are exacerbating a pattern of prior discrimination, [but] they must identify that discrimination, public or private, with some specificity before they may use race-conscious relief.”).
[44] Tenn. Wine & Spirits Retailers Ass’n, 139 S. Ct. at 2477 (Gorsuch, J., dissenting) (“But precisely because the Constitution assigns Congress the power to regulate interstate commerce, that body is free to rebut any implication of unconstitutionality that might otherwise arise under the dormant Commerce Clause doctrine by authorizing States to adopt laws favoring in-state residents.” (citing Prudential Ins. Co. v. Benjamin, 328 U.S. 408, 434–36 (1946))).
