July 23, 2019

In The Art of Selling a Cannabis Business, we covered how to address some of the hurdles involved in selling a cannabis business.  Arguably the single most important hurdle is complying with “change of ownership” rules.  Indeed, navigating the convoluted “change of ownership” rules under the Bureau of Cannabis Control (BCC) can make or break a deal. These regulations pose potential problems for the terms of the sale, and how your sale is structured and closed.  Below, we discuss the top 3 things to consider when tackling complex “change of ownership” issues under the BCC regulations and how to continue your operations during the ownership transition.

Note: This article only applies to licensed distributors, labs, retailers and microbusinesses.  The California Department of Food and Agriculture (CDFA) and Department of Public Health (DPH) have their own ownership change requirements surrounding cultivation or manufacturing licenses, respectively.

  1. State Licenses Are Not Transferable 

First, and foremost, it is important to understand that state licenses are not transferable or assignable.  In other words, a state license is not an asset that a business can just transfer or assign to a buyer.  Instead, the buyer must purchase the entity or company that holds the state license.

For example: Company X cannot buy Company Y’s state license.  Instead, Company X must buy Company Y. The end result will be that Company X is the owner of Company Y, which holds the state license.

  1. You Must Notify the BCC of Any Change of Ownership Within 14 Calendar Days.  

The BCC regulations state that “if one or more of the owners of a license change” as a result of “[a] sale or other transfer of the business or operations covered by the license,” then the new owner(s) must submit a change of ownership request with all corresponding owner information for each new owner within 14 calendar days of the closing date of the change of ownership transaction. The BCC will then vet the qualifications of the new owner(s) to determine whether the change of ownership would constitute grounds for denial of the license under MAUCRSA or the BCC regulations.

If, however, one or more owners leave the business by transferring their ownership interest to the other existing owner(s), this will not constitute a change of ownership that requires a new owner application.  In such case, the owner(s) that are transferring their interest will simply need to provide a signed statement to the BCC confirming that they have transferred their interest.

  1. If at least one existing owner stays on the license as an owner, the business can continue to operate pending BCC’s review of a change of ownership.

Unfortunately, there is no hard timeline within which the BCC has to approve a change of ownership.  And given the BCC’s backlog of license applications and its limited staff and resources,  it’s probably safe to assume that a lengthy amount of time will pass before BCC approves any change of ownership.  (Indeed, our office has heard of several instances where a change of ownership request has still remained pending despite being filed with the BCC over 6 months prior.)

Luckily, § 5023(c)(1) of the BCC regulations provide clarity on the issue of whether a business can continue operating under its active license while BCC is reviewing a change of ownership request:

“The business may continue to operate under the active license while the [BCC] reviews the qualifications of the new owner(s) in accordance with [MAUCRSA] and these regulations to determine whether the change would constitute grounds for denial of the license, if at least one existing owner is not transferring his or her ownership interest and will remain as an owner under the new ownership structure. If all owners will be transferring their ownership interest, the business shall not operate under the new ownership structure until a new license application has been submitted to and approved by the [BCC], and all application and license fees for the new application have been paid.” 

In other words, operations can continue while the BCC reviews a change of ownership so long as at least one existing owner retains his or her “ownership interest” and “remains as an owner under the new ownership structure.”  This is huge news for licensed retailers, labs, distributors and microbusiness (and their buyers) as it provides a carveout for these businesses to continue operating during a complete buyout while the BCC is processing the new owner applications (including background checks, etc.).  If you want to continue operating during a complete buy-out – as any business would undoubtedly want to do – then at least one original “owner” from the initial application must stay on the license.

What is unclear though is how the BCC will interpret the term “ownership interest” (which is, of course, not defined by the BCC).  For example, pursuant to the BCC’s definition of an “owner” under § 5003, the CEO of any licensed company must be disclosed as an owner.  But § 5023 doesn’t make clear how a company would be treated if the CEO stayed on board during a complete buy-out. So far, the BCC has been unhelpful when asked to clarify its position on this issue.

Given this uncertainty in the BCC regulations, we advise our clients to be as conservative as possible if the goal is to ensure continuity in operations during a complete buy-out.  This will typically require structuring the buy-out to occur in multiple phases:

Phase 1:  The buyer takes 80% of the company, with the remaining 20% being retained by one of the original owners.

Phase 2: The company submits a change of ownership request to the BCC along with all the required Live Scans, etc. and continues operating under § 5023 while the BCC vets the buyer.

Phase 3: After the BCC clears the buyer as an “owner,” then the original owner will be free to transfer the remaining 20% interest to the buyer.  Upon transfer of the remaining 20% to the buyer, the original owner provides a signed written statement to the BCC confirming that they have transferred their interest.

This three-phase plan is obviously not ideal from a business standpoint as it prolongs the transaction for an indefinite period of time and creates more risk for the buyer.  In most cases, however, this three-phase plan will likely be a business’ best bet at ensuring the survival of its state license and its ability to continue operating while the BCC completes its review.

As per usual, nothing in cannabis is quick (or easy). Beware of the pitfalls highlighted above and always seek proper advice and counsel before you fuck it up.

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

Contact one of our cannabis law firm specialists today by phone at 310-912-2960 or online.