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Are Cannabis Contracts Legally Enforceable?

April 9, 2021

It’s rare for an industry to undergo such accelerated growth, and the cannabis industry has recently demonstrated the potential for this trajectory. While annual revenue was estimated to be $9.2 billion in 2018, according to a study conducted by New Frontier Data1, the industry is projected to surpass $30 billion in annual revenue by 2025. Anticipated tax revenue from such a growing source is one of the many reasons that more and more states are pushing for the legalization of cannabis; however, not much has changed at the federal level. This difference in legal status impacts contracts within the industry, potentially rendering most contracts unenforceable. 

Whether a contract is related to leasing, banking, insurance or another industry, contract law dictates that the requirement of an involved party to partake an illegal activity is unenforceable. The enforceability of a cannabis-related contract is determined by a variety of circumstances: What is the language of the state statute related to legalization? When was the contract formed, and was the conduct illegal at that time? No matter the circumstance, this challenge is one that cannabis businesses and their legal teams should prepare for. 

Obviously, each state is home to different laws, and this impacts the outcome of any given legal matter. There are several recent cases that standout as examples f conflicting federal and state regulations and should be considered when assessing the potential for a similar outcome on behalf of your client’s cannabis business. Here are two examples:  

  • J.Lilly, LLC v. Clearspan Fabric Structures 
    • In Oregon, a contract dispute occurred between a commercial equipment lessor and a licensed cannabis business. J.Lilly (the cannabis company) claimed that Clearspan Fabric Structures (the lessor) did not resolve a number of defects, ultimately interfering with J.Lilly’s ability to cultivate its product. The suit filed on behalf of J.Lilly sought $5.4 million in lost profits. Ultimately, the court argued that these damages could not be awarded as this decision would mandate that Clearspan violate existing federal laws.  
  • Tracy v. USAA Cas. Ins. Co. 
    • In Hawaii, individuals are legally permitted to grow cannabis for medicinal use. In this particular case the insurance company denied the homeowner’s claim for stolen cannabis plants. Technically, the loss did fall within the category of a “covered loss” within the terms of the policy. However, the federal district court determined that the insurance company didn’t breach the contract when denying the homeowner’s claim. This decision was justified by the fact that requiring the payment of these insurance proceeds would contradict the established federal law and public policy.  

Similar disputes are regularly popping up and cannabis companies and their legal teams must be prepared. When entering a contract within the cannabis industry, enforceability is a murky area and a significant concern. Legal teams and the companies that they represent can reduce the risks of parties attempting to avoid contractual obligations by considering the following provisions:  

Alternative Dispute Resolution 

Resolving contractual disputes in arbitration is a strong approach and allows businesses to avoid the court system. Arbitration decisions typically forgo appellate review, which makes arbitrators more willing to approach disputes equitably when enforcing an agreement.2  

State Law Surrounding Cannabis Public Policy 

Due to the surge in cannabis related businesses and changes in the legality of the substance on a state level, many jurisdictions have enacted legislation that aims to protect commercial contracts.3 Remaining privy to these developments makes it easier for legal teams to avoid contractual disputes altogether.  

Provisions that Prevent Removal 

A clause can be placed within contracts that keep disputes related to that contract within the state court system. Keeping disputes out of the federal courts can be advantageous to cannabis companies, as federal courts are more likely to refuse the enforcement of cannabis related contracts.4 

Law Provision Choices 

Cannabis companies can include a provision within a contract that establishes that the contract is governed by the law of a state with more favorable cannabis laws.5 Note, however, that in order to achieve this the contracting parties must have a connection to that specific state, such as the incorporation of the contracting entity in that location.   

Federal laws related to cannabis are likely to eventually change, as the momentum of the industry seems unstoppable. When reform does occur, these issues will no longer be as relevant, but, until then, legal teams and their cannabis clients should monitor contractual disputes closely in order to mitigate the risk of unfavorable litigation.  

Round Table Group is home to some of the world’s top contract and cannabis expert witnesses, and we’d be delighted to assist on your search for an expert. For those that are unfamiliar with Round Table Group, for more than 25 years, we have helped litigators to locate, evaluate, and employ the best and most qualified expert witnesses. Round Table Groups is great complement to any litigator’s quest for an expert witness and our search is always free of charge. Visit roundtablegroup.com or contact us at 202-759-5912 for more information.  

Sources 

https://www.lexology.com/library/detail.aspx?g=2a4c53d2-d63e-4544-b52e-438d22434076 

https://newfrontierdata.com/cannabis-insights/legal-cannabis-industry-growth/#:~:text=In%202019%2C%2017%25%20of%20cannabis,be%20met%20through%20regulated%20markets. 

https://www.ncbi.nlm.nih.gov/pmc/articles/PMC6590107/ 

https://www.hkcannabislaw.com/post/the-enforce-ability-of-cannabis-contracts-drafting-to-ensure-relief-in-state-court 

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