The enactment of medicinal marijuana laws and measures permitting the cultivation and sale of recreational marijuana have created new opportunities for owners of industrial and commercial real estate. Landlords who enter into leasing transactions with marijuana related operations must take into account particular legal and business risks. This article focuses on special lease provisions that landlords should consider including in any agreement with a marijuana cultivator or dispensary in order to minimize those risks.
As a preliminary matter, except for products containing only cannabidiol (CBD), marijuana remains a Schedule I controlled substance under the Controlled Substances Act, the most restrictive of a five-level classification system and is illegal under federal law. Even in states where marijuana used for medicinal or recreational purposes is legalized, anyone directly involved in or who knowingly facilitates the cultivation, processing, distribution, or selling of marijuana for any purpose could be deemed in criminal violation of federal law.
During the Obama Administration, both the executive and legislative branches took steps to resolve this strain between federal and state law, but efforts to reschedule cannabis from Schedule 1 failed. The Justice Department issued formal guidance to federal prosecutors, often referred to as the “Cole Memoranda,” which provided some certainty of federal non-enforcement to the cannabis industry by stating that the Justice Department would limit its prosecutorial efforts to specific circumstances of concern. The Trump Administration initially rescinded Cole in January 2018, but former Attorney General William Barr subsequently stated in his confirmation hearings that the DOJ would not pursue companies who had relied on the Cole Memoranda and were operating legally in compliance with state marijuana laws. Attorney General Merrick Garland took a similar position during his recent confirmation hearing that low-level cannabis crimes would not be a priority of the DOJ, noting the negative socioeconomic effects of those law enforcement efforts.
The following lease provisions should be critically analyzed in any cannabis-related lease.
Zoning, Permitted Use and Required Licensing: The lease should require the proposed use be compliant with local zoning. Some questions to consider when analyzing the proposed use: Is the growth, distribution, storage, and/or sale of cannabis a permitted use in the municipality? Can the intended use fall under the umbrella of a different permitted use within the municipality, such as general retail or warehousing? Is any use related to cannabis specifically prohibited?
Cannabis Permit/Licensing: Consider making the lease contingent upon receipt of all local and state permits that are required in connection with the contemplated cannabis-related use. Before entering into a lease, you should consult with an attorney to review your state’s regulations and confirm that cannabis use is legal under state law, and to review the procedure to obtain the necessary permits and/or licenses. Depending on the state, the permitting and/or licensing process can be lengthy and cumbersome.
Include a tenant representation in the lease that all statements made to local and State regulators during the permit application process were and remain accurate.
Compliance with Laws: Most leases contain a requirement that the tenant comply with all applicable laws. Any cannabis-related lease is almost certainly contrary to federal law and it is a felony to knowingly open, lease, rent, use or maintain any place for the purpose of manufacturing, distributing, or using any controlled substance under the Crack House Statute, which should be addressed in the lease. You may want to include an indemnity from the tenant for any civil forfeiture actions, and a right to terminate if any federal enforcement actions are taken. However, you should require that the tenant represent that it will operate in accordance with all local and state laws.
Rent: Regulators may view anything beyond ordinary, arms-length payments as de facto license ownership, subject to disclosure and vetting. Review local rules and guidelines before entering into any sort of profit-sharing arrangement. As a landlord, avoid taking any percentage of revenues or tying the rent to any revenue thresholds if you want to maintain your independence from the licensee.
There should be a specific prohibition against paying rent in cash. Landlords should consider including a requirement that each rent installment will be paid by tenant automatically through an Automated Clearing House account.
Assignment or Sublease: It is important that you have stringent approval rights over any assignment or sublease. The tenant will make specific representations and warranties in the lease and will likely hold the permits required to operate the cannabis facility. An assignment or sublet could create significant legal risk for you that should be carefully evaluated.
Termination Rights: As a landlord, consider including the right to terminate the lease should certain events arise, including (1) denial of a local or state cannabis permit/license, (2) federal law enforcement action, (3) tenant’s non-compliance with state or local cannabis laws, and (4) material change in federal or state cannabis laws.
You should also consider the right to terminate should your lender refuse to consent to the lease, to the extent required, or declare you in default of any provision of existing loan documents due to the contemplated lease. For example, you may be in breach if your loan documents include a representation that the property will be used in compliance with all laws (including Federal law), because a cannabis-related lease does not comply with Federal law.
Utilities: If the leased property is a multi-tenant building, cultivation/processing may upset the existing proportional allocation of operating expenses. Additional water or electricity infrastructure may also be needed to accommodate the increased usage, creating additional capital improvement costs that need to be amortized and proportionally allocated.
Cannabis waste management is an important item to consider. Cultivator tenants must have strict waste management protocols in place that include securing waste on site or hauling it away under strict requirements (see below for Environmental Concerns).
Signage: Consider whether you want more stringent approval rights on any signage. This may be particularly important if the cannabis-related use will be just one of several uses on the property and if multiple tenants share signage. This is to help control the image and reputation of the shopping center/building.
Inspection Rights: Consider whether you want the ability to inspect the cannabis facility. You may want that right to ensure that the tenant is complying with local and State laws. However, States have strict rules about who may enter onto a marijuana licensee’s premises, and when. The right of the landlord to enter the premises should be clearly outlined, and it should dovetail with the provisions contained in any relevant statute or administrative rule regarding entry by anyone other than the licensee.
Security: Consider whether to require additional security measures, including the installation of security cameras or hiring security personnel on site. These measures may benefit both you and the tenant, as you will be able to better monitor compliance with the lease terms, and the tenant will have comfort in knowing that the space is secure.
Insurance: Make sure that the tenant is able to secure insurance. Marijuana business insurance coverage is currently dominated by small specialty insurers. Any lease should require that the tenant provide evidence of insurance coverage for each year that the lease is in existence, with notification to you as the property owner if the insurance lapses for any period of time. Consult with your insurance provider and consider whether you want to be included as an additional insured on the policy. While this is standard in other commercial lease relationships, you may consider forgoing this requirement to maintain independence from the cannabis use.
Consider also the effect that the use may have on your insurance as the property owner, including both property and title insurance. Will the cannabis-related use invalidate your insurance or make it more expensive? Consider passing on any costs of increased premium to the tenant.
Environmental Concerns: Address the potential for hazardous substances, fertilizers, herbicides, and pesticides used and stored at the leased premises. Address the disposal of cannabis products and byproducts. States may have both general environmental laws and cannabis specific laws that govern the storage and disposal of these items. Be sure to check clean air compliance, hazardous waste compliance (proper labeling, inspection of storage sites), clean water compliance, and State environmental regulations.
Odor Control/Nuisance: Many State and local governments regulate the emission of certain odors. At a minimum, the lease should require compliance with any such applicable laws. Also consider whether to implement more onerous requirements, particularly if the use will be adjacent to other tenant spaces and odors could create a nuisance.
The cannabis industry is expected to continue its growth as more states legalize medical and recreational cannabis use, and it may be alluring to get involved. However, it is important to acknowledge the legal risks that arise in cannabis-related leases. These lease provisions should help provoke discussion and alleviate some of the risks involved.
Peter J. Wolfson is a Partner with Day Pitney LLP in New Jersey, Gemma R. Cashman is a senior associate at the firm in Boston and Luke S. Pontier is an associate in New Jersey.