January 18, 2019

In case you missed it, California’s regulators announced last week that the Office of Administrative Law (“OAL”) officially approved regulations for all commercial cannabis licensees.  One of the most controversial rules to come from the Bureau of Cannabis Control (“BCC”) is Section 5032 (which, yes, affects all licensees across the supply chain).  Essentially, Section 5032 appears to prohibit all intellectual property (IP) licensing agreements between licensees and non-licensees, which would make California the only legal cannabis state in the country to adopt such a rule.

Some interpret this new rule as the end of white labeling in the industry. Before we get into whether or not that’s true, here’s what you need to know about white labeling — in general:

  • White labeling — also referred to as “co-packing” — is the practice of rebranding a new or existing product under another party’s name. This is usually accomplished via an IP licensing agreement between a manufacturer and a brand.
  • In the cannabis industry, white labeling allowed a licensed operator to produce, package and/or distribute cannabis products on behalf of an unlicensed entity, such as a celebrity brand or an out-of-state company.
  • White labeling is not unique to cannabis, and is widely found in a variety of industries as a means for smaller brands to gain entry into a competitive marketplace. For example, the products sold at Trader Joe’s under the TRADER JOE’S ® brand are manufactured and packaged by third parties under white labeling practices (i.e., Trader Joe’s entered into IP licensing agreements with the manufacturers who make and package their products. Trader Joe’s does not grow, make, assemble or package any of the products they sell. They are merely a retail outlet for goods produced by others.)
  • Many licensed operators do not have the skills or resources to develop new technologies or brand identities.  White labeling can provide a mechanism for these licensed operators to stay competitive in the marketplace by expanding and improving their brand and product offerings to consumers.
  • On the flip side, many companies and individuals that own IP, such as recipes, techniques, processes, and brand identities, do not have the resources to obtain local and state permits or are based in local jurisdictions that do not allow commercial cannabis activity.  White labeling can provide a mechanism for these unlicensed companies to get their products to market and collect royalties based on product sales, without ever having to touch the plant.

So, now that the final regs have been approved by OAL, does this mean that the above white labeling activities are prohibited?  No, contrary to popular belief, white labeling may still be allowed in the cannabis industry.

The new rule just makes the practice of white labeling a bit trickier to navigate. (See Section 5032 here.)   Specifically, the rule forbids licensed cannabis businesses from conducting any commercial activity “on behalf of, at the request of, or pursuant to a contract with any person that is not licensed under [MAUCRSA]].”

While this broad language surely sounds “anti-white labeling”, there actually 3 potential solutions that would comply with Section 5032:

  1. Disclose the brand entity (and all the individuals behind it) as an “owner” or a “financial interest holder” in the licensee’s state application.  In the Final Statement of Reasons, the BCC clarified that an “owner” or “financial interest holder” (“FIH”) of a licensee will not be considered “[a] person that is not licensed under MAUCRSA.”  Therefore, disclosing the brand entity as either an owner or FIH on a licensee’s application will be the easiest “workaround” for most white labeling partners. Determining whether to disclose the brand entity as either an owner or a FIH will ultimately depend on several factors.  Among others, these factors include whether the brand is participating in the “direction, control or management” of the licensee’s operations or whether the brand entity is receiving 20% or more of the licensee’s profits. But remember: anyone disclosed as an “owner” on an application will have to do a LiveScan and pass background checks.  Furthermore, the final regs now require that when an entity is listed as an owner or FIH in a licensee, all entities and individuals with a financial interest in the entity must be disclosed to the BCC “until only individuals remain.”
  2. The brand entity sells its IP outright to the licensee.  If a brand sells its IP outright to a licensee, then the IP becomes the property of the licensee.  Thus, any product branding thereafter would be outside the scope of Section 5032 because the IP owner is a licensed person under MAUCRSA.  However, this will likely be the least preferable (and most unfair) solution for most parties as it is nearly impossible to place a value on a brand at such an early stage in the marketplace.
  3. The brand entity obtains a state Cannabis Event Organizer license.  Section 5032 prohibits cannabis licensees from conducting commercial cannabis activity on behalf of any party that doesn’t have a license — but it doesn’t specify what kind of license the party must have.  Technically, a brand entity with a Cannabis Event Organizer license would be considered a licensed person under MAUCRSA.  So, if a brand entity is genuinely interested in throwing cannabis events to increase its exposure to consumers, it should probably consider obtaining a Cannabis Event Organizer license because the benefits would be two-fold: (a) it would allow the brand entity to throw cannabis “brand activation” events in any city/county that will grant it local approval; and (b) it would allow the brand entity to engage in white labeling with a licensed manufacturer without being subject to Section 5032. Note: Cannabis Event Organizer licensees would be subject to the same disclosure requirements for owners and FIH’s discussed above.

Ultimately, it seems the motive for Section 5032 is transparency. California’s regulators don’t want to ban white labeling per se, rather they’re more interested in the disclosure of all the parties who are involved in the cannabis industry, including the brands and the individuals behind them.

Need help with drafting an IP licensing agreement or re-drafting an existing one to comply with the final regs? Contact us at 310-912-2960 Manzuri Law for a consultation.

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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