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Lighting Up the Legal Scene: How Cannabis Arbitration Can Ease the Burden on California Courts

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When California opened up for recreational cannabis licensing in 2018, cannabis businesses began sprouting up like wildflowers. This growth has been exciting but due to market volatility and the decline in the state’s cannabis market, legal disputes are also on the rise. California courts are now jam-packed with cannabis-related disputes to the consternation of many judges. Thankfully, there may be a solution to this problem: arbitration. Let’s delve into how the cannabis industry got here and how arbitration can help it continue to bloom.

The Cannabis Boom

When California gave the green light to recreational cannabis, the industry exploded. Dispensaries, growers, and related businesses began to bring in billions of dollars. This boom created thousands of jobs and boosted the state’s economy, generating substantial tax revenue. However, the market began to spiral out of control due to things like regulatory overload, competition with the illegal market, high taxes, and more.

With the decline in California’s cannabis market came many lawsuits – from partnership disputes, to contract breaches, to intellectual property infringement cases, and everything in between. These cases are clogging up the courts, making it hard for businesses to get timely resolutions in an industry where time is money. Additionally, companies must navigate a complex web of local and federal laws, as cannabis remains illegal at the federal level, creating further complications and uncertainties for business owners and investors.

Judicial Concerns

The courts have noticed the surge in cannabis litigation. Before a recent bench trial, my judge expressed concern about the significant diversion of judicial resources to cannabis cases. She voiced that the unique history of cannabis combined with the informal business practices, and evolving laws, were resulting in a high volume of bench trials. The judge pointed out that contrary to cannabis disputes, non-cannabis cases with similar claims routinely settled.

Due to the strain caused by cannabis disputes, the judiciary started a grassroots campaign for change. Specifically, judges in Los Angeles are advocating for the cannabis industry to include arbitration clauses in future contracts and develop a specialized cannabis arbitration panel to ease the burden on the courts. These judges believe arbitration, faster and more cost-effective than traditional litigation, is an ideal solution for both the cannabis industry and the overburdened courts.

Is Arbitration the Answer?

Arbitration may be a lifesaver for both the California courts and the cannabis industry. It offers a much quicker way to resolve disputes compared to traditional court cases. Instead of dragging on for years, arbitration can wrap up in just a few months. This means businesses can focus on what they do best-growing, selling, and innovating and the courts can utilize judicial resources to resolve disputes as opposed to learning the intricacies of cannabis.

Additionally, because cannabis law is complex and ever-changing, arbitrators with expertise in this field are better equipped to understand and navigate challenges unique to the industry. The development of a cannabis panel to resolve disputes would be a game changer. Arbitrators on such a panel would possess specialized knowledge and skill resulting in fair and informed decisions.

However, arbitration does have downsides. Arbitration is by definition more expensive as the parties must pay the arbitrator’s costs. Additionally, there are very limited appeal rights, which means that a losing party will often be stuck with the arbitrator’s decision.

Conclusion: Lighting the Way Forward

As California’s cannabis industry blossoms, so too do its legal challenges. Arbitration is swift and expert-driven t disputes under control, ensuring businesses stay on track and courts remain unclogged. As the cannabis market surges, the embrace of arbitration must grow with it. This approach guarantees that the cannabis industry won’t fizzle but will remain hot into the future.



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What Entity Type is Best for a Cannabis Startup?

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At our firm, we’ve helped numerous cannabis startups navigate the complexities of choosing the right business entity. Because every startup is unique and has different goals and needs, a one-size-fits-all approach just won’t work. Below, I’ll explore some of the key considerations we focus on when finding the optimal entity type and structure for a cannabis venture.

The problem with sole proprietorships

Laypeople often mistakenly think that a business owned by a single person and a sole proprietorship are the same thing. Sole proprietorships, however, are generally unincorporated businesses. Imagine John Smith opens a lemonade stand and calls it John Smith Lemonade. It won’t be a separate legal entity unless he files a document with his state’s secretary of state.

Sole proprietorships like this completely miss out on “limited liability,” the hallmark of entities like corporations, limited liability companies (LLCs), limited liability partnerships (LLPs), and some other business types. Limited liability shields the owners of a business from the debts and liabilities of the business. In other words, an owner can’t be sued if the business breaches a contract or incurs another liability to a third party.

Without limited liability, a sole proprietor can be sued individually for the business’s conduct. In my sole proprietorship example above, that would be the case whether John Smith or one of his employees sold spoiled lemonade that made someone sick. Generally speaking, all of that goes away for business owners who form an entity offering limited liability (yes there are some exceptions for fraud and wrongful conduct, but those are the exceptions, not the norm).

With that in mind, I’ll talk about the two most common entity types we see in the cannabis space.

Corporations v. LLCs

Corporations have shareholders (owners) who elect directors to manage the big picture operations of the company. Directors hire officers to run the day-to-day affairs of the corporation. Depending on the state, there may be many different kinds of corporations. For example, California has general stock corporations, close corporations, and a host of non-profit corporations. All of them are different and may have different benefits for specific business types.

LLCs are much simpler. Where corporations have shareholders, directors, and officers, LLCs only have members (owners). They can (but don’t have to) appoint managers or even officers to run the business. But otherwise, LLC governance requirements are much simpler.

So the first big question for cannabis startups is how much governance they are prepared to deal with. Corporations can have a lot of benefits, but owners have to understand that they come with more governance baggage.

Which entity is better for taxation?

Corporations are taxed on their income at the federal corporate tax rate is 21%. Shareholders are then taxed on their dividends, if any are paid. This is known as “double taxation” and the “C-corporation” model. Corporations can also elect to be treated as “S-corporations” for tax purposes by making an election with the IRS within a certain timeframe. S-corporation taxation is similar to partnership taxation in many ways. However, S-corporations have many restrictions that make them impractical for some businesses.

Single member LLCs are “disregarded” for tax purposes. Multi-member LLCs are taxed on a pass-through basis (“partnership” taxation). This means that profits and losses of an LLC are treated as profits and losses of its members for tax purposes unless the LLC timely elects to have C-corporation taxation. [Note, there is also something called S-corporation taxation, which is similar to partnership taxation but outside the scope of this post.]

Despite “double taxation,” corporations may be the right entity for a cannabis business in some contexts. Here is an example of ours from a few years ago:

For example, a C corporation that earns $100,000 will pay tax of $21,000 ($100,000 *21%). If that same corporation dividends 100% of its earnings to shareholders, the maximum tax at the individual level is $23,800 ($100,000*23.8%). So the combined amount of tax is $44,800 ($21,000 + $23,800).  In comparison, a partnership (or S corporation) results in less overall tax to the owners $37,000 ($100,000 *37%).

However, a C corporation is the preferred structure if the plan is to limit the amount of dividends paid to shareholders. For example the total tax hit to a C corporation and its shareholders that paid out dividends of $50,000 is: $32,900 [$21,000+ $11,900($50,000 * 23.8%)]. In this case, a C Corporation saves $4,100 of taxes compared to operating as a partnership. The C Corporation has the additional benefit of insulating shareholders/owners from personal liability for federal income tax.

On the other hand, partnership taxation can be ideal in some circumstances, such as:

  • The individual tax brackets of the LLC members are below 37%;
  • The individual member/partners qualify for the favorable 20% deduction for flow-through income under IRC section 199A;
  • The business plan emphasizes distributing cash to investors over reinvesting cash into the business (growth);
  • The business is not a retailer, and is able to claim a reasonable amount of costs of goods sold (COGS) in its tax reporting.

None of this is meant to be tax advice, but highlights some of the key challenges businesses face in making tax and entity type decisions.

How does the parent/subsidiary company model effect entity choice?

Many cannabis ventures are structured with separate operating companies owned by a single company. Generally speaking, the operating companies are LLCs due to simplicity of operation and pass-through taxation, whereas the “parent” is a C-corporation.

Corporations tend to be the better choice for raising equity and investments, which usually happens at the parent level. Institutional investors are more comfortable investing into corporations than LLCs, where they can secure director seats, define the classes of preferred or other equity they will get, etc. Not to say this can’t be done in an LLC, but the traditional C-corporation parent model tends to be the choice of most cannabis businesses.



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Heads Up! DEA Wants to Hear from You on Marijuana Rescheduling by July 22

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In case you haven’t heard, the Drug Enforcement Administration (DEA) wants to hear from you on marijuana rescheduling. Specifically, DEA invites your comments on its notice of proposed rulemaking (NPRM) to move both marijuana and marijuana extract from schedule I to schedule III of the federal Controlled Substances Act (CSA). The comment submission deadline is July 22, 2024.

How does the comment deadline work?

There are actually two deadlines at play here. All comments must be submitted electronically or postmarked on or before 11:59 ET on July 22, 2024. All hearing requests must be postmarked on or before July 20, 2024. It’s always possible that DEA will extend the deadlines past July 20 and 22, but it seems unlikely at this point. Therefore, you should comply with the July 22 deadline to make it into the administrative record, and the July 20 deadline if you’d also like to request a hearing.

How does one submit a comment?

DOJ encourages submission of comments through the Federal eRulemaking Portal. Here is the link. The interface provides the ability to type short comments directly into the comment field on the web page, or to attach a file for lengthier comments.

I’m busy. Is there a sample comment I can adapt?

Yes, there are a couple of good ones online. Marijuana Policy Project, for example, has a template letter you can edit and submit here. NORML has one here. I’m sure there are others floating around as well.

How many comments has DEA received?

Looks like over 30,000 at the time of this writing. I initially guessed we would see over 100,000 comments. I may have overshot, but I still expect a significant uptick by next Monday.

What if I want to advocate that marijuana be re-scheduled and not de-scheduled?

You can certainly do that! I and many others have always argued that de- and not re-scheduling is the correct policy choice for marijuana. I expect that a significant portion of the comments will advocate for de-scheduling. Others will make arguments on the other end of the policy spectrum: marijuana should remain in schedule I with fentanyl and other dangerous drugs.

Wherever you land on the topic, it’s worth pointing out that DEA advised at page 13 of the NPRM that it “has not yet made a determination as to its views of the appropriate schedule for marijuana.” This is yet another reason the comment opportunity is so compelling.

Anything else to consider in the comments?

Yes. I explained in a prior post that the NPRM contemplates “marijuana-specific controls” at schedule III, although the NPRM itself doesn’t outline what those specific controls may be. It’s unclear (at least to me) whether DOJ and DEA could proceed with rescheduling marijuana prior to these controls being in place. Thus, I believe it’s fair game to comment on what controls should look like, and/or whether we even need them in the first place.

What’s the next step?

Once comments are in, the Administrative Procedure Act requires that rulemaking be conducted on the record after the opportunity for a hearing in front of an administrative law judge. It seems likely that the DEA administrator will grant a request for a hearing in this case, in order to review factual evidence and expert opinion on the NPRM.

Beyond that, you can expect this process to be ongoing at the time of the November elections. Whatever happens in those elections could also affect the outcome. But that is a topic for another day.

Until then, please keep next week’s deadlines in place, and check out the following posts on marijuana and schedule III:



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$1 Billion in Cannabis Sales in Just 182 Days?

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illinois cannabis sales records in 2024

$20 million in 12 days is how recreational cannabis first started in Illinois back in 2020.

Now, the trend in Illinois is shocking the local and Federal government.

Governor JB Pritzker of Chicago claims that on July 1, 2024, retail cannabis sales in Illinois topped $1 billion. This sum comprises around $150 million for medicinal marijuana and about $850 million for adult consumption. Remarkably, this achievement occurred almost two weeks sooner in 2024 than in 2023 on July 10, when the $1 billion threshold was attained. Furthermore, cannabis sales increased to almost $2 billion in Fiscal Year 2024 from $1.9 billion in Fiscal Years 2023 and 2022 and $1.8 billion in Fiscal Years 2022.

 

Illinois has the most equitable cannabis industry in the country, and it’s growing and thriving,” stated Governor JB Pritzker. “The increase in overall adult-use cannabis sales, along with our administration’s measures to benefit areas impacted by the War on Drugs, demonstrates how this burgeoning business is assisting us in setting a national standard for equality and economic justice. Growing sales in 2024 indicate that cannabis tax income will continue to play an important part in resolving decades of injustices in the state’s criminal justice system.

 

Illinois consumers made 81% of purchases by value in the first half of 2024, compared to 19% made by out-of-state users, according to data from the Cannabis Regulation Oversight Office. Product breakdown: 22% were consumables (liquid edibles making up 1.1% of the total), 32% were vape goods, and 49% were cannabis flower.

 

According to Erin Johnson, the Cannabis Regulation Oversight Officer, “more cannabis businesses opening means more unique products for consumers to choose from.” “We welcome these new opportunities for ownership and employment to support individuals and communities across the state in undoing the harms from the War on Drugs.”

 

The official sales numbers to not include any of Illinois black or illicit market marijuana sales.

 

Tax revenue from cannabis sales has generated over $244 million in R3 Grants for economic development, violence prevention, and youth development in disproportionately impacted communities across the state. This revenue also enabled the Illinois Department of Commerce and Economic Opportunity (DCEO) to establish the Illinois Cannabis Social Equity Loan Program, connecting those historically impacted by cannabis arrests and imprisonment with opportunities in the legal cannabis industry. To date, nearly $22 million in forgivable loans have been issued to social equity craft growers, transporters, and infusers. There will be further changes soon. Until April 2024, applications for forgiven loans for social equity adult-use dispensing groups were accepted. As long as businesses fulfill the licensing standards, conditional licensees selected in the 2022 and 2023 lotteries will get additional full dispensary licenses from the Illinois Department of Financial and Professional Regulation (IDFPR), which currently has 218 licenses for dispensaries.

 

“Removing obstacles is essential to guarantee that our labor force and sectors accurately represent the diversity of Illinoisans,” stated IDFPR Secretary Mario Treto, Jr. “We are already seeing the results of our efforts and I am excited to see what the future holds for the cannabis industry in Illinois.”

 

Rapid Growth in Cannabis Sales Outpaces Previous Years

 

On July 1, 2024, Illinois became the first state in the cannabis industry to reach $1 billion in retail sales. This incredible accomplishment came nearly two weeks ahead of schedule on July 10, 2023, when the state achieved the same milestone. The sharp rise in sales indicates the state’s increasing acceptance and demand for cannabis products. Of the $1 billion in sales, approximately $150 million was for medicinal marijuana and $850 million was for adult-use consumption.

 

Revenues for the fiscal year 2024 are expected to approach $2 billion, up from $1.9 billion in the fiscal years 2023 and 2022 and $1.8 billion in the fiscal year 2021. This represents an outstanding growth trajectory. Governor Pritzker attributes this growth to the state’s equitable cannabis economy, which aims to set a precedent for economic justice and equity across the country. The industry’s growth has been greatly aided by the administration’s commitment to helping regions affected by the War on Drugs, guaranteeing that the benefits of legalizing cannabis are experienced by all communities.

 

In the first half of 2024, Illinois residents made up 81% of the purchases by value, with out-of-state customers making up the remaining 19%, according to statistics from the Cannabis Regulation Oversight Office. According to the product breakdown, vape goods accounted for 32% of sales, cannabis flower led the market with 49%, and consumables made up 22% of sales (liquid edibles made up 1.1% of the total).

 

The cannabis market is expanding quickly due in part to the rising number of cannabis enterprises and the greater availability of cannabis products, which have given consumers more options. This expansion not only shows how well-liked cannabis is among Illinoisans but also highlights how well the state has done in creating a vibrant, welcoming cannabis industry.

 

Economic and Social Equity Initiatives Bolstered by Cannabis Tax Revenue

 

Major social equality and economic development efforts are being spearheaded by Illinois’s booming cannabis business throughout the state. Over $244 million in R3 Grants for youth initiatives, violence prevention, and economic development have been made possible by tax money from cannabis sales in communities that have been disproportionately impacted by the War on Drugs. Furthermore, the Illinois Cannabis Social Equity Loan Program was established by the Illinois Department of Commerce and Economic Opportunity (DCEO) with the help of these revenues. Nearly $22 million in forgiving loans have been given to social equity craft producers, transporters, and infusers. These initiatives are a cornerstone of the state’s commitment to leveraging the legalization of cannabis as a vehicle for community upliftment and social justice, with a focus on increasing ownership and job possibilities in the sector.

 

The Illinois Department of Financial and Professional Regulation (IDFPR) intends to complement the 218 current licenses with additional dispensary licenses to conditional licensees from the 2022 and 2023 lotteries, further strengthening these programs. As a reflection of the state’s continuous attempts to reduce entrance barriers into the cannabis industry, applications for forgiven loans for social equity adult-use distributing groups were accepted until April 2024. IDFPR Secretary Mario Treto, Jr. emphasized the value of diversity and inclusion while highlighting the encouraging outcomes of these programs thus far. Illinois is leading the country in advancing economic justice and redressing historical injustices through the expanding cannabis business as it continues to use cannabis tax income for social fairness.

 

Bottom Line

 

Illinois is a leader in the national cannabis business, as seen by its quick attainment of $1 billion in sales for 2024 and its dedication to social equality and economic justice. In addition to supporting the state’s economic expansion, the significant tax income raised goes toward financing essential initiatives meant to mitigate the negative effects of the War on Drugs. Illinois is establishing a model for how cannabis legalization may spur social development and economic prosperity, helping communities throughout the state, with its ongoing growth and inclusive regulations.

 

ILLINOIS RECREATIONAL CANNABIS, READ ON…

ILLINOIS BLACK MARKET CANNABIS SIZE

RECREATIONAL WEED IN ILLINOIS WILL CREATE A BIG BLACK MARKET!



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