April 27, 2021

5 Corporate Governance Pitfalls

Corporate documents for cannabis companies need to be carefully drafted and tailored for the unique aspects of the industry. Template documents that are found online or taken from other companies may have some useful provisions, but should not be wholly relied upon to suit the particular needs of a cannabis business. In particular, a few key issues that companies should look out for are below:

Statement of Incorporator.

The Statement of Incorporator (or Organizer, in the case of an LLC) is an important corporate formation document that is often missing from company records. Companies are created by filing Articles of Incorporation with the Secretary of State, and are often incorporated by an attorney, accountant or other agent on behalf of the principal business owner. The Statement of Incorporator is an official written statement by the incorporator that gives up their authority in the company and vests it in a director or directors. Oftentimes this statement is missing, and there are just the Articles, and then a resolution by the directors issuing shares, appointing officers or ratifying other company actions. However, without the Statement of Incorporator, the directors were never actually granted authority to act on behalf of the company. Thus, if there is ever a dispute with the incorporator, they may be able to claim an ownership interest in the company. So it is important to have them transfer authority to the principal immediately after filing the Articles, and before the company takes any other acts.

Number of Directors.

Another issue we often come across is corporations with the wrong number of directors. In California, Corporations must have at least three directors, unless the number of shareholders is less than three, in which case there must be at least as many directors as shareholders. So a company with one shareholder must have at least one director, and a company with two shareholders must have at least two directors. It is important that a company have the proper number of directors. Owners of companies that do not observe these types of corporate formalities may not be afforded the protections that come with the corporate form if they are ever brought to court.


Bylaws govern a company’s voting procedures, shareholder meetings, the appointment of directors and other internal matters. In California, a corporation is not required to have bylaws unless the Articles do not specify the number of directors, in which case a corporation must have bylaws. However, we almost always recommend that companies have bylaws, otherwise they will be bound by relevant provisions of California corporate law, which may be different from the rules they want to put in place for their company.

Ownership Disclosure.

Initial Representations

Pursuant to California law, all “owners” (as defined by the State) of a cannabis business must be disclosed to the State, and many local jurisdictions have similar requirements. It is important to be familiar with both the state and local requirements, as a cannabis business could risk losing licensure if it is owned by someone who is disqualified as an owner under the relevant legal provisions. Thus, it is important to be familiar with these provisions at the outset, and have well-drafted representations and warranties from each owner that they (1) qualify as an owner (2) will continue to qualify as an owner, and (3) will cooperate in being disclosed to the state and local local licensing authorities.

Ability to Remove

It is also important to include language in your corporate documents that allows you to remove an owner who has become disqualified under the relevant legal provisions. This language should be clearly drafted and included in an agreement that all owners have signed, so that any necessary removal or transfer can be conducted as smoothly as possible. There are several approaches to this issue. One method is to add language to your operating documents stating that any owner who becomes disqualified under the relevant statutory and/or regulatory framework can transfer their equity to a person of their choice, provided that all the other shareholders consent, and that such transferee qualifies as an owner for regulatory purposes. Furthermore, it is important to ensure that the new owner joins the relevant operating documents simultaneously with the transfer of the shares, so they are bound by the same terms as everyone else.

Definition of Owner.

Under California law, someone is an owner of a cannabis license if they are “participating in the direction, control, or management of the person applying for a license.” And as noted above, anyone who is an owner must be disclosed to the State. Given this definition, people other than equity holders could qualify as owners, and in some cases, third party contracts could trigger ownership disclosure requirements. For example, if a cannabis company licenses IP from another company, the licensor may have to be disclosed as an owner. Quality control provisions or other language giving the licensor influence over the product that its IP is used with could potentially constitute “control” for purposes of disclosure requirements. Thus, it is important for cannabis businesses to review their IP agreements (and all other contracts), to make sure that they don’t inadvertently have “owners” who have not been disclosed to the State. Reach out to us if you need more clarity or assistance to thoroughly and correctly craft your cannabis business’ corporate documents.

Disclaimer: This article has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice.