March 31, 2021

Welcome to California

Although cannabis is illegal at the federal level, it has been legalized in an increasing number of states in recent years, and is currently legal for either medical or recreational use in 36 states. However, although cannabis is legal in more than 2/3 of states, every state that has legalized cannabis has prohibited both importing and exporting cannabis, even between states where cannabis is legal.  Some states also favor in-state residents in the provision of licenses required to engage in commercial cannabis activity, which encourages such activity to remain within state borders. Thus, there are 36 markets for cannabis in the United States that are entirely closed off from one another.

It is unusual for states to pass laws that regulate interstate commerce, as it is a well-established legal doctrine that such restrictions are the exclusive jurisdiction of the federal government, namely, the United States Congress. Under the commerce clause of the Constitution, Congress has the power to regulate interstate commerce. In fact, the commerce clause provides the constitutional backing for the Controlled Substances Act. In Gonzales v. Raich, the Supreme Court held that Congress can regulate activities that occur strictly within the borders of a state, including the cultivation and use of cannabis, on the basis that such activities, in the aggregate, affect supply and demand at the national level, and thus, have an impact on interstate commerce. And through its decisions, the Supreme Court has developed a legal doctrine known as the “dormant commerce clause”, which holds that such power belongs exclusively to Congress, so states do not have the ability to restrict commerce between the states, or to discriminate against out-of-state residents in relation to commercial activity.

The dormant commerce clause is based on free market principles designed to provide the lowest price to consumers. When states close their borders to cannabis from other states, they protect their producers from competition and prevent their residents from buying cannabis from out-of-state producers who may be able to offer a lower price. Some states have imposed import/export restrictions under the belief that the federal government is less likely to interfere with legal regulated cannabis within states if the states prevent interstate commerce. Oregon, for example, passed a law allowing for the export of cannabis, but only if the federal government approved. However, each of these state-imposed restrictions are likely violative of the commerce clause, and, if challenged, should be invalidated, which will allow for the emergence of a national legal cannabis market, and will have far-reaching implications for the industry.

In fact, certain state cannabis laws have already been challenged and defeated in federal court. In NPG, LLC v. City of Portland, Maine, a company interested in opening a retail cannabis store challenged a local ordinance that favored in-state residents in the awarding of retail licenses. The city argued that the restriction was valid because the Controlled Substances Act banned cannabis altogether. However, the court disagreed, stating:

the [Controlled Substances] Act nowhere says that states may enact laws that give preference to in-state economic interests. In other words, although the Controlled Substances Act criminalizes marijuana, it does not affirmatively grant states the power to ‘burden interstate commerce ‘in a manner which would otherwise not be permissible.’

Although this case was directly about in-state residency requirements, import/export restrictions should be struck down using the same logic, as they too burden interstate commerce. 

Over time, more and more state restrictions will likely be struck down and a national market will emerge where cannabis is able to flow freely across state borders. This will have several major impacts on the industry. For one, a majority of outdoor cannabis cultivation will begin to occur in states where the climate is more conducive to cannabis cultivation, such as California and Oregon. These states will grow cannabis that will be sold into other states, as it will be cheaper for certain states, such as Nevada, to import cannabis than to grow their own. Thus, a national market should be beneficial to California cannabis cultivators, as California will likely be a net exporter of cannabis. Furthermore, the Emerald Triangle region of California has developed a strong reputation for producing quality cannabis, which should increase sales nationally. 

A national market will also accelerate consolidation in the industry as gains from economies of scale will be more readily available. In the current environment, a multi-state operator (“MSO”) must have separate operations in each state where it does business. Although certain functions like accounting, IP development and marketing can already be shared by operations in different states, all plant-touching activities must be replicated in every state where the MSO does business. A national market would allow MSOs to fully integrate their supply chain to drive efficiencies in their business and deliver lower prices to customers. The opportunity to take full advantage of interstate supply chains will incentivize cannabis companies to build connected operations across multiple states. As state restrictions fall, the industry will see accelerated change in the coming years. Please contact us if you have any questions about how these issues may affect your business.

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

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