May 16, 2019

Cannabis Leases: Top 10 Things to Consider

There’s no such thing as a “basic” cannabis contract — and commercial cannabis leases are no exception.  Unlike with standard commercial leases, cannabis landlords and tenants must navigate the inconsistencies (indeed, outright conflict) between federal and state law, the complexities of state and local laws and regulations, and unpredictable licensing timelines.

With that said, here are my top 10 important items to consider when negotiating and drafting a cannabis lease:

  • Defining the Permitted Use.

Both parties need to explicitly agree on exactly what type of commercial cannabis activity will be allowed on the premises.  It’s not enough to simply write “cannabis activity” or “lawful commercial use only.” For example, if the tenant intends to operate a medical and adult-use storefront dispensary, the permitted use should state something to the effect of: “Commercial medicinal and adult-use storefront retail cannabis activities.”   If you’re a landlord, you’ll also want to make sure the permitted use is contingent upon the tenant’s strict compliance with applicable local and state laws and regulations.

  • Exclusion of the Federal CSA From “Applicable Law.”

As with any cannabis contract, a cannabis lease needs to address the federal illegality that overhangs the industry.  Standard A.I.R. and C.A.R. forms require that the tenant not use the premises for any “unlawful” purpose. Arguably, this means that a landlord can evict a cannabis tenant at any time due to the fact that cannabis remains illegal under the federal Controlled Substances Act (CSA).  While it would likely be an uphill battle for a landlord to evict solely on the grounds of federal illegality when the lease itself expressly allows commercial cannabis activity as a permitted use, it would save everyone time, money and headaches if both parties stipulated in writing that “applicable law” excludes the CSA (i.e., a violation of the CSA would not be considered a breach under the lease).

  • Secured Interests.

If a landlord’s property is financed, federal illegality could potentially impact the landlord’s mortgage on the property. Often times commercial mortgage loan docs will have provisions prohibiting nuisances and/or requiring “compliance with all laws” (which, by default, includes federal). Because a cannabis tenant could jeopardize a landlord’s compliance with those requirements, it’s important to consider the possibility that the landlord could be held in breach by its lender, and the lender may call the loan due in full and assess hefty penalties, which would obviously be a nightmare for both parties.  In such an event, the landlord may want the option to terminate the lease early without penalty. Alternatively, the tenant may want the option of providing the landlord with alternative financing (i.e., a hard-money loan), or paying the difference in interest rate between the landlord’s traditional loan and subsequent refinancing.

  • Asset Forfeiture and Indemnity.

While the threat of federal enforcement against state-compliant cannabis activity seems more and more unlikely nowadays, the risk (however remote) will always exist so long as cannabis remains federally illegal.  A shrewd landlord will require a tenant to indemnify the landlord from civil forfeiture action under the CSA, meaning that the tenant will be responsible for defending the landlord and covering the landlord’s losses in the event that the feds take enforcement action against the landlord for renting to a cannabis business.  Additionally, a landlord should push for making any such enforcement action constitute a default under the lease.

  • Escape Clauses.

Both parties will typically want to carve out certain “escape clauses” into the lease, which allows a party to terminate the lease early without penalty in particular cannabis-specific situations.  For landlords, these situations often include the following: actual or threatened civil or criminal liability of any kind, a tenant’s non-compliance with state or local cannabis laws, or a change in applicable laws or federal enforcement policies which would materially increase the risk of liability to the landlord or the premises.

Tenants, on the other hand, will often push for the right to terminate the lease early in the event that the tenant is unable to obtain a state or local license within a certain period of time.  Because quick-and-easy temporary state licenses are now a thing of the past, it can take several months for an applicant to obtain a local license and then several months thereafter to obtain a state annual license. This means that a tenant could end up paying for months (or, in some cases, years) of premium rent without the ability to operate and generate an income.  Typically, when a landlord gives the tenant an option for early termination in the event it’s unable to obtain a state or local license, the landlord will require the forfeiture of the tenant’s security deposit. Another common solution to account for delays in licensing is to incorporate rent abatement terms into the lease.

  • Notice and Cure Provisions.

Under state law, C.A.R. forms generally provide tenants with only a 3-day opportunity to cure a violation of the lease before the landlord can move forward with eviction.  In the cannabis world, however, 3 days is usually never enough time to resolve an issue. For example, if a tenant experiences a lapse in licensing due to a deficiency in its annual application, this could be considered a default under the lease.  Even if the deficiency is easy to fix, government agencies are notorious for their delays in responding so it’s almost impossible to cure the violation within such a short period of time. To account for such delays, the tenant should negotiate that any violation of the lease based upon the suspension or termination of a license should be deemed to have occurred once the tenant has exhausted all available remedies and opportunities to cure or appeal such suspension or termination. If the landlord refuses, the tenant should request — at the very least — a 30-day notice and cure period for non-monetary defaults.

  • Landlord Access Rights.

Standard form leases typically give landlords the right to access the leased premises at any time with reasonable notice for things such as inspections, maintenance/repairs and showings to prospective purchasers.  However, California has strict rules about who may enter a licensed premises, and when. If a landlord has unfettered access to restricted or limited access areas, this could place the licensed tenant in violation of the Medicinal and Adult Use Cannabis Regulation Safety Act (MAUCRSA) and thereby place the tenant’s license in jeopardy, which benefits no one.   Accordingly, form leases should be amended to make the landlord’s access and inspection rights subject to the state’s restrictions in MAUCRSA.

  • Landlord Cooperation.

Because most cannabis licenses are tied to locations, a cannabis tenant will want to ensure that its property owner is obligated to cooperate and assist with the licensing process.  For instance, in order to obtain a local and state license, the applicant must provide a signed affidavit from the property owner indicating that the applicant has a legal right to occupy and use the premises for commercial cannabis activity.   Tenants should therefore require that the property owner cooperate by signing the affidavit in a timely manner so as to ensure that the tenant is able to submit all required documentation by applicable deadlines.

  • Defining Hazardous Materials.

Both the A.I.R. and C.A.R. forms prohibit the usage and storage of “Hazardous Materials.”  Because the definition of “Hazardous Materials” is non-cannabis specific and somewhat vague (i.e., anything “potentially injurious to the public health, safety or welfare, the environment or the premises,” or anything “regulated or monitored by any governmental authority,” etc.), it’s important for tenants to exclude cannabis, cannabis byproducts, cannabis waste, fertilizers, herbicides and pesticides from the definition of “hazardous materials,” along with any other potentially hazardous substances that the tenant (especially a manufacturer) intends to use.

  • Landlord’s Consent for Assignment.

If you’re a tenant hoping to secure outside investors sometime during the term of the lease, and the landlord insists on using an A.I.R. form, pay close attention to Paragraph 12.1 buried within the standard form lease.  This paragraph essentially boils down to the following standard: that a change in 25% control of the tenant’s business will constitute an assignment of the lease, which requires the landlord’s consent. In other words, if you find an investor for 25% or more of your company, you will need the landlord’s consent in order for the lease to be transferred along with the change in control.  If the tenant does not obtain the landlord’s consent, the landlord may elect to treat the unapproved assignment as a non-curable breach and either terminate the lease, increase rent and/or charge an assignment fee plus costs and attorney’s fees. This type of a restriction can significantly impair the attractiveness of your company to investors so it’s important for fundraising tenants to negotiate beforehand the terms under which a tenant can assign the lease.

The above list is by no means exhaustive, and every cannabis lease will be unique depending on the parties, property, activity type and jurisdiction.  But as you can see, drafting a cannabis lease is no easy task. If you’re entering into a cannabis lease, whether as a tenant or a landlord, feel free to contact our California Cannabis & Hemp Litigation Attorneys today at Manzuri Law to set up a consultation for expert advice.

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