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Cannabis M&A: Protecting Against Undisclosed Liabilities

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When someone buys a cannabis business, and not just that business’s assets, they essentially inherit all of its liabilities. And there are usually a lot.

If the business is in the midst of a lawsuit, owes back taxes, is behind on rent, etc., the buyer will need to deal with those problems on its own–unless the purchase agreement requires some form of assistance from the seller.

Smart cannabis business buyers spend a lot of time doing “diligence” on the target business either before signing a purchase agreement or before closing, in large part to flag potential liabilities. But in some cases, buyers fail to ask the right questions or sellers (whether intentionally or not) fail to disclose material information about the business.

We call these “undisclosed liabilities,” and if they are not properly addressed in the purchase agreement, they can lead to serious problems for the buyer. Below, I’ll identify a few common ways that buyers protect themselves from undisclosed liabilities.

Conducting thorough due diligence

You probably wouldn’t buy a car without test driving it, making sure title was clear, and maybe even having a mechanic check it out. So would you buy a business without making sure you weren’t walking into a minefield first? You’d probably be surprised at the amount of folks who would.

The first and best way to avoid undisclosed liabilities is to thoroughly diligence the target business. The diligence process usually involves lawyers sending written questionnaires to the seller’s counsel, seeking a host of information about the business.

A good diligence questionnaire will include information about its finances, debt, real estate, employment matters, litigation, corporate structuring and governance, intellectual property, owned and leased assets, licensing and regulatory matters, and so on. Increasingly they will include things like privacy law compliance and other “newer” legal concerns.

This is really only the start — the buyer’s counsel and tax/financial advisors will review many of the documents and flag concerns for the buyer. Buyers may also do things like physical inspections of the business premises or assets.

Concerns raised in the diligence process will drive negotiations with the seller and in some cases necessitate changes to the deal structure. In more extreme cases, a buyer may walk altogether.

In the next few parts of this post, I’ll address tools sophisticated buyers use to proactively mitigate liabilities that were not disclosed in the due diligence process.

Indemnification

One of the most common risk-mitigation strategies in business purchases is requiring the seller to indemnify the buyer in the event that the buyer suffers harm as a result of certain identified acts or omissions of the seller. These usually include inaccuracies in representations by the seller or breach of the purchase agreement by the seller.

For example, a purchase agreement may state that the seller must indemnify the buyer and company (as well as their affiliates) against harm they may suffer as the result of seller’s breach of a representation. Say there was a representation by the seller that the company owed no back taxes, when in fact it did and the tax collector came knocking, the buyer could require the seller to pay the back taxes and defend it in any tax proceeding.

Indemnification provisions can be incredibly complicated and heavily negotiated. For example, sellers will often push for a cap on their indemnification obligation, since after all, a seller wouldn’t want to end up responsible for paying more than they were paid in the deal to cover the buyer’s expenses. Buyers on the other hand may push for carveouts to seller caps in cases of fraud or concealment of material undisclosed liabilities.

Additionally, indemnification provisions only really work to the extent that the seller has money to actually indemnify the buyer. A good rule is to assume that once the seller is paid, it (and its money) will vanish from the face of the earth, leaving the buyer left holding the bag regardless of how well it negotiated an indemnification provision. Still, buyers have a few options to protect against this.

Offsets and holdbacks

One easy way (in theory at least) to protect against a disappearing seller is to ensure that money will be tied up post-closing. There are two main ways this typically happens.

First, buyers may establish a holdback of part of the purchase price to be held in a neutral escrow account for some period following the closing. For example, if the purchase price is $5mm, the buyer may insist that $750,000 is held for a year in an escrow account post-closing, and that any liability that arises during this time may be satisfied out of the escrow fund.

Second, where any part of the purchase price or consideration will be paid or granted post-closing, the buyer may include an offset provision similar to the escrow holdback. Rather than having a pot of money held in escrow, the buyer could simply deduct future payment. Where part of the purchase price is paid via a seller note or post-closing installments, offset provisions are common. But they can also be used against things like post-closing options, warrants, or earnout provisions.

Conclusion

Undisclosed liabilities are the bane of any sophisticated buyer’s existence. Thinking proactively about mitigation strategies early on can save buyers headache and financial misery down the road. Cannabis M&A is no easy task and buyers who address undisclosed liabilities head on will be in a lot better position down the road.

For more on cannabis M&A, check out some of our other posts below:



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US Court Rules Delta-8 THC Derived from Hemp is 100% Legal, Slamming the DEA in Embarrassing Court Case

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supreme cour ruling on delta-8 thc from hemp

In a groundbreaking decision, the U.S. Court of Appeals for the Ninth Circuit has ruled that Delta-8 tetrahydrocannabinol (Delta-8 THC) derived from legal hemp sources is not classified as a controlled substance under federal law, directly contradicting the Drug Enforcement Administration’s (DEA) position that all synthetically derived tetrahydrocannabinols, including Delta-8 THC, fall under Schedule I controlled substances. This landmark ruling emerged from a case brought forward by several key players in the hemp industry who challenged the DEA’s interpretation of the 2018 Farm Bill, which legalized hemp and its derivatives. The court’s decision not only rejects the DEA’s restrictive stance but also provides much-needed clarity regarding the legal status of Delta-8 THC, allowing for its continued production and sale from legally sourced hemp. This ruling is significant as it has the potential to reshape the regulatory landscape for cannabinoids, encouraging further exploration and commercialization of hemp-derived products while also highlighting the ongoing tensions between federal regulations and the rapidly evolving hemp industry.

 

 Delta-8 THC: A Naturally Occurring Cannabinoid

Delta-8 tetrahydrocannabinol (Delta-8 THC) is a naturally occurring cannabinoid found in trace amounts in hemp and cannabis plants that shares a similar molecular structure to Delta-9 THC, the primary psychoactive compound in marijuana, but is known to produce significantly milder intoxicating effects; the 2018 Farm Bill’s legalization of hemp and its derivatives containing no more than 0.3% Delta-9 THC on a dry weight basis created a legal gray area for Delta-8 THC, which has proliferated in the form of various products derived from legal hemp sources and sold in a largely unregulated market, as they are not explicitly classified as controlled substances by the Drug Enforcement Administration (DEA) despite the agency’s stance that all synthetically derived tetrahydrocannabinols should be treated as Schedule I drugs regardless of their origin or potency, a position that has been challenged by hemp industry players arguing that Delta-8 THC from legal hemp should be exempt from the same restrictions as Delta-9 THC.

 

 The DEA’s Stance and Industry Challenges

The Drug Enforcement Administration (DEA) has taken a firm stance that all synthetically derived tetrahydrocannabinols, including Delta-8 THC, are classified as Schedule I controlled substances under the Controlled Substances Act (CSA), regardless of their source or concentration. This position has faced considerable resistance from various stakeholders within the hemp industry, who argue that Delta-8 THC derived from legal hemp should not be subjected to the same stringent restrictions as Delta-9 THC, the primary psychoactive compound in marijuana. Proponents contend that the 2018 Farm Bill, which legalized hemp and its derivatives, should extend to include Delta-8 THC, allowing it to be treated as a legal product when sourced from hemp that contains less than 0.3% Delta-9 THC. They emphasize that while Delta-8 THC may occur naturally in small amounts in hemp, the majority of Delta-8 products on the market are produced through a chemical conversion process from CBD, which the DEA argues renders them synthetic and thus illegal. This conflict has led to ongoing legal challenges, with some courts ruling in favor of the hemp industry, asserting that Delta-8 THC should not be classified as a controlled substance when derived from legal hemp. As the debate continues, the tension between the DEA’s regulatory framework and the evolving hemp market raises critical questions about the future of cannabinoid regulation in the United States.

 

 The Court’s Ruling and Its Implications

 

The U.S. Court of Appeals for the Ninth Circuit ruled that Delta-8 THC derived from legal hemp sources is not controlled substance.

  • The court found the DEA’s interpretation of the law was “arbitrary and capricious” and lacked a reasoned explanation.

  • This ruling effectively removes Delta-8 THC from the DEA’s list of controlled substances, provided it is derived from hemp containing less than 0.3% Delta-9 THC.

  • The decision provides legal protection for businesses and consumers involved in Delta-8 THC products derived from legal hemp sources.

 

 

Opportunities for the Hemp and Cannabis Industries

The recent court ruling represents a significant victory for the hemp and cannabis industries, paving the way for new possibilities in product development and research.

  • Therapeutic Potential: Delta-8 THC has been recognized for its potential therapeutic benefits, which could attract more consumers seeking alternative treatments.

  • Increased Investment: The legalization of Delta-8 THC may lead to heightened investment and innovation within the sector, encouraging the development of new products and formulations.

  • Regulatory Concerns: Despite the positive implications, the ruling also raises important concerns regarding the regulation and quality control of Delta-8 THC products, necessitating careful oversight.

  • Need for Standards: As the market for Delta-8 THC expands, there will be a pressing need for clear guidelines and standards to ensure consumer safety and product consistency, helping to build trust in these emerging products.

Broader Implications for Cannabis Legalization

The court’s ruling underscores the ongoing conflict between federal and state laws concerning the regulation of cannabis and its derivatives.

  • Increasing State Legalization: As more states advance toward the legalization of both recreational and medical marijuana, the pressure on the federal government to revise its policies and align them with shifting public opinion is likely to intensify.

  • Step Forward for Delta-8 THC: The ruling regarding Delta-8 THC may be viewed as a positive development in the broader context of cannabis legalization, yet significant challenges remain.

  • Path to Comprehensive Legalization: There is still a considerable distance to cover before achieving comprehensive federal legalization of cannabis, highlighting the complexities of navigating cannabis policy in the United States.

 

Conclusion

 

The court’s ruling underscores the ongoing conflict between federal and state laws concerning the regulation of cannabis and its derivatives. As more states advance toward the legalization of both recreational and medical marijuana, the pressure on the federal government to revise its policies and align them with shifting public opinion is likely to intensify. The ruling regarding Delta-8 THC may be viewed as a positive development in the broader context of cannabis legalization; however, significant challenges remain, and there is still a considerable distance to cover before achieving comprehensive federal legalization of cannabis, highlighting the complexities of navigating cannabis policy in the United States.

 

DELTA-8 THC IS LEGAL, READ MORE…

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What Is It, Why You Should Care, and How Cannabis Helps

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metabolic syndrome

Metabolic syndrome is an umbrella term referring to several conditions that negatively impact how the body metabolizes carbohydrates, fats, and proteins.


It occurs when there are unusual, abnormal chemical processes in the body which affect otherwise healthy metabolic functions. The primary symptoms of metabolic syndrome include abdominal fat, high blood pressure, high blood sugar, high triglycerides, and low levels of LDL (good) cholesterol. These conditions all greatly increase the risk of stroke, coronary heart disease, diabetes, and other severe health issues that are difficult or near impossible to reverse.

 

The most telling symptom, though, is a large waist circumference – and you don’t need to take any kind of medical test to tell you this because it’s completely visible.


That’s why prevention is key when it comes to metabolic syndrome. However, the choices you make on a daily basis in your lifestyle can determine your risk for metabolic syndrome of not. We know that an unhealthy diet that is high in sugar, salt, and processed food can contribute to the symptoms of metabolic syndrome. A sedentary lifestyle, obesity, poor sleep hygiene, and exposure to chronic stress can also make the risk much worse. Smoking tobacco and alcohol are even worse – don’t even think about it.


But cannabis? That can actually help!

What Studies Say

 

A recent study that was published in the American Journal of Open Medicine found that young adults with a habit of consuming cannabis had a significantly lower prevalence of metabolic syndrome. For the study, investigators from the University of Miami analyzed a cohort of almost 4,000 individuals whose ages ranged from 18 to 25. They specifically zoned in on the young adults’ cannabis use.

 

They found that current cannabis users were 42% less likely to have metabolic syndrome. They also found that Non-Hispanic Blacks, who were consuming more weed than the other subjects, were found to be the least likely of all to have metabolic syndrome. “Current cannabis users had a lower prevalence of MetS, predominantly noted among NHB (non-Hispanic Blacks], the group with the highest prevalence of current cannabis use,” said the study’s authors. “Future prospective studies are warranted to examine the role of specific cannabinoids on MetS by race/ethnicity,” they said.

 

A Smaller Waist Circumference: Why You Should Pay Attention, And How Weed Can Help

 

Having a large waist circumference or a visibly fatty belly has been associated with numerous health conditions. Of course, this includes a heightened risk of metabolic disease. It also increases the risk of inflammation, type 2 diabetes, cardiovascular disease incidence, and cancer among others.

That is why it’s critical to pay attention to the size of your stomach. A smaller waist means you have a smaller amount of visceral fat, which is necessary for better health and an improved quality of life.

There are many steps you can take to reduce your visceral fat. These include:

 

  • Sticking to a low carbohydrate and low sugar diet

  • Having a diet high in good protein sources

  • Reduce consumption of trans fat and saturated fats

  • Engage in strength training and cardiovascular exercises

  • Manage stress effectively

 

Last but not the least: did you know that consuming cannabis has been shown to be associated with smaller waistlines and a reduced risk for obesity?

In 2020, a study out of Quebec in Canada revealed that cannabis consumption was linked to a smaller waist and reduced triglyceride levels. For this study, the investigator in Canada analyzed subjects who either never consumed marijuana in the past, used it sometime in the past but had no recent use, had some infrequent use, or consume it infrequently. They specifically measured the participants’ waist circumference and triglycerides.

 

They found out that the subjects who consumed certain marijuana strains for metabolic syndrome for at least 4 days per week were found to have smaller waistlines as well as less triglycerides compared to the other participants in the study.

 

Another study from 2015, also out of Quebec, was conducted by researchers from the Conference of Quebec University Health Centers. They analyzed cannabis consumption patterns of 786 Arctic aboriginal adults, the Inuits. The investigators also analyzed their body mass index to search for any links between cannabis use and BMI.

They found that study participants who consumed marijuana within the last year were more likely to have a lower body mass index, as well as reduced fasting insulin and better insulin resistance (using the HOMA-IR indicator) compared to those who did not.

“In this large cross-sectional adult survey with high prevalence of both substance use and obesity, cannabis use in the past year was associated with lower BMI, lower percentage fat mass, lower fasting insulin, and HOMA-IR,” said the researchers. In other words, they observed a relationship between cannabis use and BMI that led them to conclude that cannabis and cannabinoid use can help consumers reduce the likelihood of obesity and diabetes.

 

Meanwhile, an older study from 2013 also had similar results. Research data from The American Journal of Medicine taken from more than 4,600 patients yielded interesting findings. Almost 45% of patients never consumed marijuana in their lives, while 43% of them smoked in the past though no longer do currently. And 12% of them were regular cannabis users.

Researchers discovered that cannabis users who consumed marijuana within the past month had 16% less fasting insulin levels compared to those who never consumed weed. In addition, they even add reduced HOMA-IR levels and higher high-density lipoprotein. Furthermore, the investigators found that regular cannabis users who usually consume more calories, they also had lower BMI’s.

 

Conclusion

 

Staying fit and healthy is much more than vanity: science and medical research makes it clear that there is a strong link between obesity and body mass index, to overall health and wellness. Metabolic syndrome further emphasizes the importance of keeping one’s BMI normal, and based on these studies, that’s something cannabis can help with. Integrating responsible cannabis use into your lifestyle is one tool out of many that can help you stay healthy and reduce the risks of developing metabolic syndrome.

 

MORE ON METABOLIC SYNDROME AND WEED, READ ON…

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More Bad News for Intoxicating Hemp (California, Missouri, New Jersey)

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Last week, I wrote a post entitled “Loper Comes For the DEA. Will it Matter Though?” In that post, I discussed a brand new federal Fourth Circuit Court of Appeals case that concluded that hemp derivatives like THC-O are not controlled substances. The hemp community has largely celebrated this as a win, even though as I wrote in that post and back in July, none of this really matters if Congress bans intoxicating hemp products – which looks like it will happen.

On the heels of the Fourth Circuit case, a few things happened that don’t make life easier for people who want intoxicating hemp products.

Probably the most significant of the bad news, the California Department of Public Health (CDPH) issued emergency regulations to ban a series of intoxicating hemp products. A lot has been written about these regulations, but it’s worth pointing out that California’s hemp law (AB-45) was already not very favorable to smokable hemp products.

For example, AB-45 already prohibits smokable hemp products. And more notably, it defines THC to include THCA and “any tetrahydrocannabinol, including, but not limited to, Delta-8-tetrahydrocannabinol, Delta-9-tetrahydrocannabinol, and Delta-10-tetrahydrocannabinol, however derived”. In other words, all of the various things that are defined as THC – and there are many – must already not exceed 0.3% in the aggregate. This means that a host of products were already de facto banned in the state.

While, to be sure, the new emergency regulations take things farther, I think it would be inaccurate to describe this as a “sea change” in how hemp products are regulated in the state. What remains to be seen is whether CDPH or other agencies ramp up enforcement in any meaningful way. It’s California, so my guess is no.

California’s not the only state taking aim at intoxicating hemp products. Just the other day, Missouri’s Attorney General created a new task force to crack down on intoxicating hemp products. New Jersey’s Governor also signed a bill cracking down on intoxicating hemp products.

All this just adds to the long list of states and municipalities that had been going after unregulated intoxicating hemp products prior to the Fourth Circuit’s decision – often for violations of state or local law which are unlikely to be impacted by the federal case. And of course, if Congress gets around to banning intoxicating hemp products, that will likely be the last straw for many of these products.



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