Without the option to declare bankruptcy—due to federal illegality—the only recourse for cannabis businesses in distress to become solvent and / or distribute assets to creditors is to enter into an expensive and difficult judicial cannabis receivership. Receiverships are inherently adversarial, and the required input from third-party experts, lawyers and regular engagement with the courts can be incredibly costly.

Meanwhile, businesses operating in mainstream sectors have the ability to declare bankruptcy. This is also a court-ordered procedure that allows companies to satisfy lenders by liquidating assets, restructuring operations and finances, and to enjoy a break of sorts to make deals with creditors and renegotiate contracts and leases. Without a change to federal banking laws, cannabis companies are blocked from the benefits of bankruptcy, and the situation is only getting worse.

Given the current tight capital market environment, the increase in cannabis distressed assets, and the shortage of options to cannabis operators to address said challenges, is there a possible alternative option to alleviate the rather dire situation?

Genesis—Transition from Equity Financing to Debt Financing

Equity financing has been the most prominent way to raise capital in cannabis for the last several years. However,recent data collected by Viridian Capital Advisorsreveals that debt currently makes up 93% of capital raised by U.S. cannabis cultivation and retail companies, compared to 55.7% in U.S. industries overall.

This change in the capital-raising environment, which has led to an increased number of creditors in the sector, combined with continued market pressures on cannabis businesses to remain competitive, make it highly likely that the industry will inevitably see more receiverships.

Ultimately, while debt financiers are willing to lend cannabis businesses money, they expect to be paid back on time and often with high interest. If the business begins to struggle and enters a distressed phase that leads to receivership, the business assets will be sold off and the secured lenders will be the first to get paid, while the business itself is likely not to recover much.

Consider an Administrative and Collateral Agent

With receiverships punishingly expensive and the debt financing landscapebordering on predatorial, distressed cannabis businesses are desperate for any assistance or support available.  An Administrative and Collateral Agent (ACA) could be the alternative support required, benefitting borrowers, lenders and regulators alike, and offering a more cost-effective and less punitive option to courts, receivers and lawyers.

Instead of dealing with the courts and an expensive court-appointed receiver, cannabis companies seeking relief could turn to an ACA to facilitate mediation between parties and create alignment within the industry, which does not exist today.

An ACA could create a level of trust, transparency and complementary positioning with industry participants that simply has not yet existed in cannabis. The use of an ACA could challenge the competing perceptions that there is already alignment between regulators, operators and lenders, or that a useful alignment between these parties could ever exist.

An ACA could be a real and valuable tool for state governments and regulators as they begin to understand that it is in their best interests to assist cannabis businesses in their states in the face of continued federal illegality and restrictions. Under a private agreement between parties, the ACA would conduct something more akin to an administrative receivership as opposed to the traditional judicial receivership that is the only current option for insolvent cannabis businesses to seek relief.

Building upon a Cannabis Credit Rating Framework

Ideally, an ACA would work within an industry-specific credit rating system for cannabis businesses in distress in order to work within an established framework for potential investors. If cannabis companies are ranked across an equitable, systematic and formulaiccredit rating system, borrowers, lenders and regulators would benefit from the quantifiable transparency afforded by said rating, and debt financing would have an inherent regulatory-like structure to prevent predatory lending. By avoiding the courts, the distressed cannabis company would save time, money and create a more attractive scenario for potential lenders.

Initial Path to Mitigating Solutions

While the current challenges facing cannabis businesses today are well documented and have risen to both creditors and regulators attention, a viable solution has yet to be identified. Most likely no one solution exists beyond waiting for the economic and capital environments to evolve. Yet, mitigating options do exist.

The introduction of an ACA is one such option. Questions remain as to the mechanics, regulatory, operative and fiscal alike, as well as who to trust to take it on. The introduction of a credit rating framework is the first step to creating a solid foundation from within which an ACA can operate transparently and equitably. Any potential buy-in from regulators, creditors and operators remains an open question.

All of that said, there is today an unprecedented set of market forces that is pushing all cannabis stakeholders to think outside of the box. The still growing opportunities in the cannabis industry, the will of operators to survive and succeed, as well as the increasing exposure from creditors, all point to not only an acceptance for the need of an alternative, but to the drive to do things differently.

Is your cannabis business in distress? Would you benefit from expert guidance and support in deciding on whether to enter into a receivership?Reach out to United CMC today.

On March 17, 2023, the Commonwealth Court of Pennsylvania issued a decision regarding employee use of medical marijuana in the workers’ compensation context.  The decision in Fegley v. Firestone Tire & Rubber (Workers’ Comp. Appeal Bd.) addresses an issue of first impression.  The court held that an employer’s failure to reimburse an employee’s out-of-pocket costs for medical marijuana to treat his work-related injury was a violation of the Pennsylvania Workers’ Compensation Act (“WC Act”).  The decision is significant for Pennsylvania employers.  Given this decision, Pennsylvania employers could be subject to penalties under the WC Act if they do not reimburse employees for medical marijuana use—even though marijuana is illegal under federal law and cannot be prescribed by any doctors.

CASE BACKGROUND

The employee in the underlying case sustained a work-related injury to his back.  After decades of taking prescribed opiates and narcotics, the employee began using medical marijuana at the recommendation of his doctor.  His pain level improved through use of marijuana, to the point that he was able to wean himself off of the prescription drugs.  An entity responsible for evaluating the appropriateness of treatment for work-related injuries under the state workers’ compensation system found that the employee’s medical marijuana use was reasonable and necessary.  However, the employer refused to reimburse the employee for the cost of his medical marijuana treatment.

The employee filed a claim seeking penalties for the employer’s alleged violation of the WC Act by failing to pay for the cost of his medical marijuana use.  The employer prevailed at the agency level on the grounds that the Pennsylvania Medical Marijuana Act (“MMA”) says that coverage is not required for medical marijuana and requiring an employer to fund marijuana use would violate federal law and did not violate the WC Act.  The employee then appealed to the Commonwealth Court of Pennsylvania.

DECISION ON APPEAL

In a 5-2 decision, the Commonwealth Court of Pennsylvania disagreed with the agency ruling below, and thus reversed and remanded.  In reaching its decision, the Court analyzed the contours of, and the relationship between, the WC Act, the MMA, and related federal law.

Starting with the basics, the Court observed that the WC Act requires reimbursement to employees for reasonable and necessary medical expenses resulting from work-related injuries.  The Court also observed that the MMA deems marijuana to be a legitimate therapy for treatment of medical issues under proper circumstances.  And the MMA seeks to protect individuals who use medical marijuana by stating that medical marijuana patients shall not be “denied any right or privilege, . . . solely for lawful use of medical marijuana . . .”

The MMA, however, also has a section entitled “Conflict”, which provides that “[n]othing in [the MMA] shall be construed to require an insurer or a health plan, whether paid for by Commonwealth funds or private funds, to provide coverage for medical marijuana.”  This did not end the Court’s inquiry.  The Court found that the absence of the word “reimbursement” in this Conflict provision is significant.  While a well-reasoned dissenting opinion described “coverage” and “reimbursement” as “two sides of the same coin”, the majority disagreed.  The Court held that “coverage” and “reimbursement” have materially distinct definitions.  The Court reasoned that the MMA does not require coverage for medical marijuana, but there is no language in the MMA precluding a WC carrier from reimbursing a claimant for medical expenses that are reasonable and necessary to treat a work-related injury.  In the Court’s view, employers must therefore reimburse employees for medical marijuana treatment that is reasonable and necessary for work-related injuries.  This conclusion, the Court noted, is consistent with the WC Act’s reimbursement requirement, along with the MMA’s endorsement of medical marijuana and corresponding prohibition against the denial of rights or privileges based solely on medical marijuana use.

The Court also addressed the relationship between state and federal law.  The MMA contains a provision stating that [n]othing in [the MMA] shall require an employer to commit any act that would put the employer or any person in violation of federal law.”  Under federal law, it is unlawful for “any person knowingly or intentionally – [] to manufacture, distribute, or dispense, or possess with intent to manufacture, distribute, or dispense, a controlled substance[.]” 21 U.S.C. § 841(a).  The Court did not find this to be a persuasive reason for reaching a different decision because reimbursement is not the same as manufacturing, distribution, or dispensing of marijuana.  Thus, reimbursement is not illegal.

In her dissent, Judge Christine Fizzano Cannon discussed the interplay between state and federal law.  She wrote that “[a]lthough the MMA legalizes the use of medical marijuana in Pennsylvania, a provider still cannot legally dispense medical marijuana under federal law” because it is illegal.  She reasoned that an illegal treatment cannot be reasonable or necessary under the WC Act and, in turn, an employer should not be responsible for reimbursement.

KEY TAKEAWAYS

This decision—unless it is overturned or superseded—has immediate impact on employers in Pennsylvania.  Indeed, they are now required to reimburse employees for medical marijuana treatment for work-related injuries under the WC Act.  Failure to do so could result in penalties.  This holding is consistent with holdings in New Mexico, New Jersey, New Hampshire, New York and Connecticut.  However, it is contrary to holdings in Massachusetts, Maine, and Minnesota.

Cannabis tax revenue remains a central argument for legalization. In the decade since adult-use markets first launched, local, and state governments have allocated billions of dollars in collected cannabis taxes to fund educational infrastructure, substance abuse prevention and treatment programs, public safety and many other initiatives designed to improve the lives of those living in states with legal cannabis markets.

There is an irony here. It is almost as if the drug war has turned in on itself, with money from the once demonized cannabis plant being used on treatment and support of individuals addicted to pharmaceutical opioids, alcohol, and other “legal” drugs.

It’s also important to scrutinize how cannabis taxes are structured and acknowledge the harms of overregulation and overtaxation, something we have seen at Holland & Hart time and again helping licensed operators navigate complex cannabis regulations for tax collecting, license transfers, reporting, and other compliance matters. One thing is clear: while the goals are noble, cannabis taxation has its flaws and unforeseen consequences.

Types of Taxes on Cannabis

Tax structures governing cannabis sales vary across legal markets. Some states levy multiple taxes (such as an excise tax on wholesale transfers), and local governments commonly impose their own separate taxes. Of course, all of these cannabis taxes get passed to the consumer, who may also pay general state and local sales taxes on their purchases.

The complexity doesn’t end there. States tax various cannabis products in different ways, including: a percentage-of-price tax, a weight-based tax, and a potency-based tax. For example, Washington levies a 37% sales tax on cannabis purchases, while Illinois does not have any sales tax but does levy a 7% excise tax of value at the wholesale level, a 10% tax on cannabis flower or products with less than 35% THC, a 20% tax on products infused with cannabis, such as edible products, and a 25% tax on any product with a THC concentration higher than 35%.

Cannabis Tax Revenue Funding

All of those percentages of sale add up quite quickly and are allocated in different ways. Some of the cannabis tax revenue goes to education-related initiatives like school construction, school food programs, before- and after-school enrichment programs, and public libraries. Other funding is directed toward public health and community programs like alcohol and drug treatment, job training, conviction expungement, and services for veterans. Investment in traditionally underserved or underdeveloped communities is also common in some states.

It’s important to note that tax structures are subject to change due to sunsetting legislation, ballot initiatives, and other bureaucratic maneuvers. Here is where the money currently goes in some of the states with the highest returns from cannabis taxation.

Colorado

Colorado voters legalized adult use of cannabis in 2012 and state-licensed dispensaries started sales in 2014. Colorado levies a standard state sales tax (2.9%), a retail marijuana sales tax (15%), and a retail marijuana excise tax (15%) on wholesale sales/transfers of retail marijuana. In 2021, Colorado recorded $423,486,053 in cannabis tax revenue.

The state allocates 10% of the collected marijuana retail tax to local governments, apportioned according to the percentage of sales occurring within city and county boundaries. The remaining 90% is allocated as follows:

• 15.56% of the revenue goes to the General Fund
  • Education
  • Health care
  • Human services
  • Corrections
• 12.59% goes to the Public School Fund
• 71.85% goes to the Marijuana Tax Cash Fund
  • Health care
  • Health education
  • Substance abuse prevention and treatment programs
  • Law enforcement
  • Education
    • The School Health Professional Grant program to address behavioral health issues in schools.
    • A grant program to help schools and districts set up initiatives to reduce the frequency of bullying incidents.
    • Grants to fund drop-out prevention programs.
    • Early Literacy Competitive Grants to ensure reading is embedded into K-3 curriculum.
    • A grant to expand concurrent enrollment programs.
    • Grants to fund physical education courses and social-emotional health programs for K-5 students.

Revenue from the excise tax of wholesale sales goes to the Building Excellent Schools Today (BEST) fund. The first $40 million collected annually is earmarked for capital construction projects “to repair or replace Colorado’s most needy public school facilities.” The cannabis money is commingled with State Land Board proceeds, Colorado Lottery spillover funds, and interest accrued in the Public School Capital Construction Assistance Fund. Matching funds are required by statute and calculated based on a series of factors, from the particular district’s bond election efforts over the past 10 years to the district’s assessed value per pupil. School projects completed thanks to the BEST fund include HVAC and electrical upgrades, fire and safety improvements, roof replacements, adding ADA-compliant restrooms and abating hazardous materials.

In Denver, the City Council recently announced approval to use approximately $15 million of Denver’s cannabis sales tax for the city’s first investment program focused on minority and women-owned businesses. Establishing quality job opportunities, a pipeline of entrepreneurs and small business startups, and generational wealth for Denver-based business owners who have historically lacked investment opportunities, are the goals of the Malone Fund.

Washington State

Washington launched adult-use sales in 2014, a few months behind Colorado. With its 37% cannabis retail tax coupled with a 6.5% standard retail sales tax, the state pulled in $559.5 million in 2021. Some of the funds directed to public health and research include:

• The state health authority for an annual healthy youth survey
  • Measure drug use and other behaviors that contribute to morbidity, mortality, and social problems
• The University of Washington for marijuana-related educational programs
• The state’s health professions account
  • Provides an accounting and resource allocation vehicle for licensing activity of health professions
• Various state departments for research related to pesticides, licensing, accreditation, and testing

California

The largest legal market in the nation adopted laws for legal adult use in 2016 and collected staggering $1.3 billion in revenue in 2021. The initial taxation arrangement for cultivators was $10.08 per ounce for flower, $3.00 per ounce for leaves, and $1.41 per ounce for fresh plant. But, on July 1, 2022, through AB 195 California announced it would remove cultivation taxes and instead impose a 15% excise tax on retail purchases of cannabis or cannabis products beginning in January 1, 2023. Beginning in the 2025–26 fiscal year and every two years thereafter, California will determine whether the cannabis excise tax rate should be adjusted to ensure revenue generated is in line with what would have been collected through the cultivation tax to a maximum of 19% of the gross receipts of retail sales.

This is how the California distributes its cannabis taxes:

• All regulatory and research costs must be covered first
• 60% goes to anti-drug programs
  • Youth Education Prevention, Early Intervention and Treatment Account (YEPEITA)
    • Prevention and early intervention services including outreach, risk survey and education to youth, families, schools, primary care health providers, behavioral health and SUD service providers, community and faith-based organizations, foster care providers, juvenile and family courts, to recognize the reduce risks related to substance use, and the early signs of problematic use.
    • Grants to schools to develop and support Student Assistance Programs, designed to prevent and reduce substance use, and improve school retention and performance. Schools with higher than average drop-out rates will be prioritized for grants.
  • 20% goes to environmental programs
    • Combat illegal grows and wildland restoration
    • Road improvement
    • Local park investment
  • 20% goes to public safety
    • Science and policy research
    • Law enforcement
    • Fire protection
    • Local programming to address public health and safety associated with the implementation of Proposition 64.

Elsewhere, Missouri voters in 2018 adopted Constitutional Amendment 2, known now as Article XIV, which includes a provision requiring that fees and taxes generated by the medical marijuana program, less operational expenses, be transferred to the Missouri Veterans Commission for health and care services for military veterans. Since dispensary sales began in October 2020, more than $335 million in sales have occurred—with almost $9 million going to veterans as of the end of 2021—thanks to a sales tax rate of 4% on medical marijuana.

In Oregon, police and mental health treatment centers receive funding, but the biggest recipients are the state’s schools, which receive 40% of the state’s cannabis tax revenue.

At the national level, cannabis remains illegal, but among various bills in Congress, the MORE Act (Marijuana Opportunity Reinvestment and Expungement) has passed the House and if (ever) approved by the Senate, would establish a sales tax at 5% which would increase to 8% over three years. The tax would be imposed on the retail sales of cannabis and proceeds from the tax would go to a newly established Opportunity Trust Fund. A new governmental organization, the Cannabis Justice Office, would be tasked with overseeing the social equity provisions of the MORE Act.

50% of the money would support a Community Reinvestment Grant Program, 10% would support substance misuse treatment programs, and 40% would go to the federal Small Business Administration to support implementation of a newly created equitable licensing grant program. The Community Reinvestment Grant Program would provide eligible entities with funds to administer services and programs for individuals adversely impacted by the War on Drugs.

While the industry has worked with governments to establish reasonable taxation regimes, excessive taxes will drive consumers to the black market. Using cannabis taxes as a resource to fill budget gaps created by tax favoritism of other industries is not a solid approach to responsible fiscal policy. In order for the legalization of cannabis to be a long-term success, the industry, legislatures, regulators, and even prohibitionists need to work together to make sure the safer legal cannabis market is not overtaxed to the point that it can no longer survive.

Source: JD Supra

https://www.jdsupra.com/legalnews/cannabis-taxation-where-does-the-money-6588066/