California’s New Regs Say ‘Goodbye’ to Brokers, Branding

On Friday, California’s three cannabis licensing agencies released revisions to the proposed permanent regulations. Some of the changes were minor, while others took the industry by surprise. By far, the most significant changes came from the Bureau of Cannabis Control (BCC). Public comments will be accepted through November 5, 2018.

Why we have regulations in the first place

Before getting too far into the specifics of some of the more substantial changes, it is important to understand that regulations merely clarify existing law; regulations do not create law.  Specifically, here in California, the BCC, CalCannabis and the Manufactured Cannabis Safety Branch are authorized to adopt regulations pursuant to California Business & Professions Code §26013. Subsection (c) of that statute limits these agencies’ authority by mandating that, “regulations issued … shall be necessary to achieve the purposes of this division, based on best available evidence, and shall mandate only commercially feasible procedures, technology, or other requirements, and shall not unreasonably restrain or inhibit the development of alternative procedures or technology to achieve the same substantive requirements, nor shall such regulations make compliance so onerous that the operation under a cannabis license is not worthy of being carried out in practice by a reasonably prudent businessperson.” In other words, the agencies should only be adopting regulations designed to increase legal participation by commercial cannabis businesses.

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With that in mind, one of the largest shocks to the cannabis industry came in Section 5032, which previously only dealt with the distinction between the M (medicinal) and A (adult use or recreational) license types. That section was essentially rewritten to allow business activity between licensees regardless of the M or A designation. No big deal right? Wait for it…

White-label branding just got more difficult

Behind closed doors, it is fairly common to “work under” a license that belongs to another person or entity, which is fine, so long as the regulators are aware of the arrangement. The new regulations confirm that licensed operators may not conduct commercial cannabis activities on behalf of, at the request of or pursuant to a contract with an unlicensed person or entity. This includes, “packaging and labeling cannabis goods under a non-licensee’s brand or according to the specifications of a non-licensee.”

What does this mean for companies that consider themselves a “brand” but do not have a license? Brands will need to either obtain their own distribution or manufacturing license or be listed as an owner on the license held by the manufacturer who performs white labeling on their behalf. This indeed has always been the position advanced by the BCC. However, it remained unclear in the regulations until October 19, 2018.

A blow to cannabis brokers

Section 5032 also put a damper on the business of brokering cannabis transactions. The new regulations state that procuring cannabis goods from a licensed cultivator or manufacturer without a license is also a banned practice. While everyone knows that cannabis goods can only move through the supply chain through licensed distributors, it appears that the BCC is now restricting who can profit from arranging for that distribution.

Moreover, Section 5004 now makes it clear that anyone who shares in the profits of the commercial cannabis business, including commission salespersons and brokers, must be disclosed as financial interest holders of the business.

Landlords, brokers, and the individuals behind business entities are all financial interest holders

Other financial interest holders named in the new version of Section 5004 are employees with profit sharing plans, landlords who take a cut of the business profits, consultants who receive a share of profits, attorneys, accountants and other agents who receive a share of profits, brokers and commission salespersons. If an entity has an ownership or financial interest in a commercial cannabis company, each human being that makes up that entity is also considered a financial interest holder. Each of these parties must be disclosed on the application as financial interest holders. The requirements of financial interest holders are not overly cumbersome and include listing the name, address, phone number and government-issued identification number.

Many investors are up in arms over this regulation. They believed that by putting one or more business entities between them and the licensed entity, they would avoid public disclosure of their investment activities. This is no longer the case. Although this reaction is understandable, it is equally important that the BCC know who the real players are in the cannabis industry.

Expanded definition of “owner”

Similarly, Section 5003, which defines “owners” was revised to include an, “individual who assumes responsibility for the license.” An individual who assumes responsibility for the license means anyone who manages or directs the business for a share of profits (i.e. management companies); someone who assumes responsibility for the debts of the commercial cannabis business; anyone who determines how any part of the business is run, including the non-plant-touching parts, such as marketing and branding; and individuals who determine which strains will be cultivated, products to be manufactured or goods to be distributed, purchased or sold.

Alcohol regulations provide potential solutions

Since BCC Chief Lori Ajax comes from the alcohol industry, we may see California follow the registration processes adopted by the ABC (Department of Alcoholic Beverage Control).

For example, California could seek to solve the white labeling and branding problem by following the Beer Brand Registration model California implemented in 2016. The ABC allows beer brands to register and disclose whether the beer is “contract brewed.”  The BCC could easily implement a single form registration, possibly accompanied by a live scan and owner disclosures, to regulate, but keep alive the white label market.  White labeling provides market efficiencies and opportunities for those who are unable to obtain commercial cannabis licenses due to local restrictions. Moreover, it makes no sense for a brand to comply with the onerous local requirements for permitting and licensing California cannabis businesses

Again, borrowing from alcohol, the BCC could easily resolve the broker issue by requiring brokers to register with the BCC just as wine brokers must do with the ABC.  If the issue is for the BCC to know who is participating in the legal market, the solution is registration and disclosure, not prohibition, which we all know only serves to bolster the thriving black market.

Changes to applications and license information to satisfy regulation requirements

Alternatively, looking back to Section 5004, brokers, brands and those contracting for white label services can be added to a legal operator’s license. The BCC released an updated form that will allow licensees and applicants to update their information to include or remove owners and financial interest holders.

Other interesting revisions

Other notable changes to the regulations include a general increase in licensing fees imposed by the BCC for retailers, distributors, microbusinesses and testing laboratories; the ability of distributors to roll prerolls, rather than only being able to package them; increasing the inventory reconciliation frequency from 14 business days to 30 calendar days; Cal OSHA approved 30 hour training requirements; clarification as to what areas of a licensed cultivation site can be shared by multiple licensees or licensees with more than one license; written plans, processes and procedures required of manufacturing licensees; and updates to the child resistant packaging regulations that will allow child resistant exit packaging to serve as an alternative to the child resistant package that contains the product itself until January 1, 2020.

These revised proposed permanent regulations are not final just yet. Interested parties have until November 5, 2018 at 5:00 PM to submit their public comments. The regulators can only be as reasonable and as effective as the information provided to them.  One thing is certain, come December 2018, California should finally have a firm set of regulations in place.

Dana Cisneros Esq.Dana Leigh Cisneros, Esq., focuses on real estate, contract, commercial, business, and corporate law. She uses knowledge and experience acquired over more than a decade to further her clients’ interests and avoid complicated legal issues in the complex cannabis industry. CannabisCorpLaw.com

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