As the Cannabis Industry Grows, Legalization Begets Litigation

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Historically,  the cannabis industry has been an unpredictable and dubious place to conduct business. When deals were negotiated in the black and gray markets, they most often were looseknitcontractssealed with a handshake. In the new legal market, business practices are more regulated and formalized, but that doesnt mean disputes and brouhaha are any less common.

If ever there were an industry that could use some good lawyering, cannabis is it. The weed biz represents the opportunity of a lifetime for brave souls who step into the fray. For business owners, its imperative to retain a lawyer, or two, who understand complex cannabis laws and compliance issues in the city, county, and state where they operate. For those who go it alone, caveat venditor.

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Law firms across the country have taken a keen interest in the emerging billiondollar business sector, and with more than half of U.S. states now permitting some form of legal cannabis operations, lawyers are gearing up for a new wave of civil and criminal litigation that is sure to provide some compelling characters and case law in the years to come.

Cannabis 101: contract disputeslegal-watch_1124192069_web_mg magazine

Over the past fifty years, drug war lawsuits primarily were criminal cases against growers and distributors. Headlines hyping busts of thousands of pounds, complete with photos of weed bonfires and neatly bundled stacks of cash were on full display. Going forward, lawsuits will be less showboating and more mundane, garden variety cases: contract disputes, wage and working conditions claims, product liability suits, and landlordtenant quarrels, to name a few.

Sean McAllister is a seasoned cannabis attorney whose firm, McAllister Garfield P.C., has expanded its presence from Denver and now maintains offices in Los Angeles, the Bay Area, and Miami. After representing clients in Colorado during the United Statesfirst recreational cannabis experiment, McAllister predicts California and other West Coast operators will experience some growing pains, with a wide array of civil suits along the way.

With the constantly changing regulations, I see a majority of companies not achieving the level of success they expect,” he said. “That leads to frustration and lawsuits between business partners, and thats the dominant litigation I see in the cannabis business.”

A typical example, he explained, occurs when one member of a limited liability company or corporation butts heads with other owners or directors who are all on the same page. If the disagreement becomes bad enough that the individual sues the companywhich generally has a significant advantage because of its resourcesodds the plaintiff will win usually are slim to none. “Even if a partner has a right to be bought out, maybe the other side doesnt like the valuation of the business that is made, so they tell the partner to go pound sand,” McAllister said. “If youre fighting about $50,000 to $100,000, its rarely worth your time. The partner left in the cold who wants justice usually ends up very frustrated.”

Employment disputes and product liability

After so many years operating in the gray and black markets, adjusting to the norms of a regulated workplace is very difficult for many cannabis businesses and their employees. Say goodbye to cash payouts, sparking up doobies in the breakroom, and first Friday forklift battles in the company parking lot. Say hello to time cards, taxes, and worker safety and health standards.

One of the ripest areas for litigation in the cannabis industry is employment disputes, where employees file complaints against a company over issues such as wageandhour law violations, wrongful termination, sexual harassment, and discrimination.

Employment disputes will be a huge exposure for businesses that have been operating in the gray market,” said Katy Young, a SanFranciscobased attorney who specializes in business disputes and real estate claims. “Nobody would have sued for that before, but there have been rampant violations of wageandhour laws in the cannabis industry.”

As regulatory agencies keep an eagle eye on cannabis businesses in newly legal states, mandatory inspections, workplace safety, and financial reporting procedures could mean the difference between success and failure in the early stages of a companys operations.

I work with a wide spectrum of cannabis businesses in Oregon, and I advise them to be extra careful in all aspects because they are under more scrutiny than other businesses as far as complying with local, state, and federal tax laws,” said Anthony Johnson, a cannabis consultant and attorney in Oregon. “You need to have resources available to hire lawyers, accountants, and other really good people who understand how to follow the rules.”

Alongside employment suits, another area ripe for litigation is product liability, wherein a company is sued for defective, faulty, or misused products that cause injuries, property damage, or business interruptions.

In a recent highprofile case, a Los Angeles man filed a proposed class action suit against vape cartridge manufacturer Brass Knuckles, testing lab SC Laboratories, and celebrity owner/endorser Xzibit, claiming the manufacturers THC oil concentrates seriously strained his health. The plaintiff, Ignacio Lee, alleged he used Brass Knuckles vaping cartridges in July 2016 and consistently repurchased the Candy Apple and Sour Diesel varieties for several months before he began experiencing symptoms including fatigue, headaches, and nausea. According to court documents, Steep Hill Labs tested the products and founddetectable amounts of pesticides including Bifenazate, Etoxazole, Myclobutanil, and Trifloxystrobin.”

Not only can product liability claims cost companies by way of expensive lawsuits and damages, but courts and regulatory agencies can demand product recalls, remediation procedures, more stringent testing procedures, and other actions that can impact a companys procedures and bottom line.

McAllister, too, has seen a plethora of disputes and businesstobusiness litigation around pesticides and contamination. “People have done a bad job of papering up contracts between suppliers and producers and retailers, so when they get a bad batch, there isnt an obvious remedy in the contracts,” he explained. “Weve seen a lot of this in Colorado, where a bad batch of product can end up costing hundreds of thousands in lost sales.”

To wit: In August, the California Bureau of Cannabis Control reported of the nearly 11,000 samples tested during the first two months of mandatory testing in the state, almost 2,000 failed due to inaccurate label claims and unacceptable levels of pesticides, solvents, and bacteria.

Trademarks and intellectual property

Because intellectual property protection is a federal issue, its difficult for cannabis companies to qualify for trademark protection. Nevertheless, many lawyers believe IP and patent disputes will be a hot topic as the industry expands.

There is an entire industry of IP lawyers who have figured out how to get some level of protection,” Young said. As companies begin establishing their brands in new regions of a state, or into other states, they often encounter other brands with similar names. “Just like weve seen in the craft beer industry, there are a lot of names that sound really similar in cannabis, which will lead to disputes,” she said.

McAllister noted many of the trademark disputes he has reviewed in Colorado have resulted in peace agreements under which companies agree to split regions where they use the name or make some similar arrangement. In the realm of patent infringement, however, there is likely to be more activity as companies start testing the waters against competitors with similar products and technologies.

In one of the first cases of its kind in the industryand the first patent lawsuit about a product that is illegal at the federal levelUnited Cannabis Corporation (UCANN) this past summer accused Pure Hemp Collective Inc. of patent infringement. In the complaint, filed in federal court in Colorado, UCANN alleged Pure Hemps tinctures, gel capsules, and vape pens violate one or more of UCANNs patents forcannabis extracts and methods of preparing and using same.” According to documents filed in the case, testing revealed a Pure Hemp product contained “[a] liquid cannabinoid formulation wherein at least 95 percent of the total cannabinoids is cannabidiol (CBD).”

Given cannabis is federally illegal, the court may decline to hear the case. If the case proceeds, the judge could invalidate the patent as overly broador he could determine the patent is enforceable. The latter decision would give UCANN case law for future legal action against companies that manufacture cannabis extracts meeting the same description.

The ultimate disposition of the lawsuit will provide guidance about the viability of cannabisrelated patents.

Dont forget about the feds

While attorneys agree most of the cannabis industry lawsuits going forward will resemble lawsuits in traditional business sectors, there will be cases with enough sizzle to satisfy the lawandorder crowd too. In the cannabis world, sizzle is spelled RICO.

In Oregon, Colorado, and Massachusetts, several Racketeer Influenced and Corrupt Organizations Act cases currently in play could have a dramatic impact as the cannabis industry unfolds on the national and international stage.

RICO, which was crafted to make prosecuting drug cartels and organized crime rings easier, allows concurrent criminal and civil prosecution of groups of loosely related entities as acriminal enterprise.”  Thus far, RICO cases aimed at the cannabis industry have focused onadjacent property nuisanceissueslike, for example, the one filed in July by Sandy, Oregon, resident Laura Underwood. Underwood sued her neighbor, Oregon Candy Farm, on the grounds OCCs extraction operation damaged her propertys value. The lawsuit names as criminal conspirators all 200 cannabis businesses with which OCC has had any dealings, ever. The rationale behind the RICO charge is cannabiss federal status.

The strategy began in Michigan and Colorado in 2017 and has become increasingly popular among antilegalization activists nationwide. So far, the tactic hasnt been very successful. The Colorado and Michigan cases are ongoing, but one Oregon suit settled out of court last year. A second was dismissed by U.S. District Judge Michael McShane on the grounds the injuries plaintiffs allegedreduced property values, unpleasant noises, and foul odorswere not appropriate for RICO arguments. However, McShane also ruled the plaintiffs may refile.

Avoiding litigation

Its no secret compliance and success go hand in hand in the cannabis industry. In order to survive, companies must maintain good communications with city and state regulatory agencies and have inhouse auditing and standard operating procedures that ensure all rules are followed to a T.

Henry Wykowski, a SanFranciscobased attorney and a founder of the National Cannabis Industry Association, believes companies in newly legal states should be laserfocused on compliance and regulations. “We monitor compliance trends so we can get out in front of them before these issues become problems,” he said. “You have to be nimble and have a good sense of where things are going, because an ounce of prevention is worth a pound of cure.”

The National Cannabis Bar Association met in Washington, D.C., this summer, where lawyers from across the U.S. met to trade notes and discuss the state of the industry. There, Katy Young offered advice about avoiding litigation:

  •  Have an attorney draft entity documents, vendor contracts, and purchase orders. A little money on the front end can save a lot of money on the back end.
  • Know and understand the rights and obligations created by each document.
  • If a dispute might end up in litigation, get advice from a litigation attorney before the disputeblows up.”
  • Be reasonable when negotiating. Often, this means consulting a litigation attorney prior to taking a position.
  •  Insert mandatory mediation provisions in all documents.

Above and beyond these practices, Young said cannabis companies must take the extra step of buying insurance to protect themselves from claims that are better resolved outside the confines of a courtroom.

Some of the best case law has been about insurance coverage, and the precedents should carry over,” she explained. “There will be badfaith litigation in the cannabis industry, just like in any [other] industry, so people are wising up and buying insurance policies to cover their business.”

With so many different types of potential legal disputes, business operators also would be wise to choose their representation carefully and identify lawyers who have the expertise and experience to handle the complexities of the situation. With all the Johnnycomelatelies entering the cannabis realm, choosing the right attorney is an undertaking in and of itself.

Im concerned that there are so many lawyers holding themselves out there who say they have expertise in this area but dont,” said Wykowski. “One thing we do a lot of is cleaning up messes that prior lawyers have created because they didnt know what they were doing.”

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