Clearing the Haze: State Laws and Private Plaintiffs Critical to Preserve Competition in Cannabis

• Publication year: 2021

Ausra O. Deluard and Jennifer M. Oliver^*

Abstract: Legalized cannabis is an exciting and blossoming industry, but regulations are nascent and compliance is complicated and costly. Licensed operators face numerous challenges that black- and gray-market competitors avoid, thus increasing their competitive advantage to the detriment of legitimate cannabis operators. And that is where, through strategic use of unfair competition laws, private plaintiffs can play a key role. This article explores the panoply of competition issues in the exploding cannabis industry, including cases already filed and the challenges we expect to see in the future.

You have heard the cliches: legalized cannabis is the Wild West, a new frontier, a modern-day gold rush. It is an exciting and blossoming industry, to be sure, but regulations are nascent and compliance is both complex and costly.

Licensed operators face numerous challenges. Here are just a few: onerous federal tax interpretations that prevent expense deductions, state and city taxes and licensing fees, lack of banking options and the ability to use credit card networks, strict regulations that limit advertising and marketing efforts, stringent testing standards to prevent the use of harmful pesticides and other chemicals, and evolving rules and interpretations.

Black- and gray-market competitors avoid many of these challenges, thus increasing their competitive advantage to the detriment of legitimate cannabis operators. As the State of California's Cannabis Advisory Committee has reported, "fragmented and uncoordinated" enforcement has allowed the black market to flourish, "threatening licensed business with unfair competition."¹ But, state and local enforcement is hampered by a lack of resources. And that is where private plaintiffs can play a key role.

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Questions Around Federal Enforcement, For Now

We begin with a threshold question many observers of the exploding cannabis market have pondered: Do federal antitrust laws apply to an industry that is legal in many states, but not under federal law? Because cannabis remains prohibited under the federal Controlled Substances Act (CSA), its legal manufacture and distribution is limited to intrastate activities. While some cannabis companies have presences in several states, often referred to as "multi-state operators" or "MSOs," cannabis product cannot cross state lines. Does this mean that consumers of cannabis products may be less protected from inflated prices caused by anticompetitive conduct, such as abuse of category captain arrangements² or agreements to fix prices or allocate markets?

The Supreme Court has broadly interpreted activities that occur entirely intrastate to nonetheless affect interstate commerce. In Wickard v. Filburn, the Court expansively read the Commerce Clause to apply to a farmer's personal cultivation and consumption of wheat because it "exert[ed] a substantial economic effect on interstate commerce."³ The farmer had argued that his intrastate, and unsold, cultivation should not be regulated as interstate commerce described in the Constitution as "Commerce . . . among the several states."⁴ The Court decided that his personal cultivation reduced the amount of wheat he would buy for animal feed on the open market, which is traded nationally and thus interstate. The Court also considered that rising market prices of wheat could draw such wheat into the interstate market, resulting in lower market prices. Decades later, the Supreme Court applied Wickard v. Filburn to hold that the CSA applied to personal cultivation of cannabis for medical use. In Gonzales v. Raich, the Court explained that the high demand in the interstate market would draw such homegrown cannabis into that market, holding "the regulation is squarely within Congress' commerce power because the production of the commodity meant for home consumption, be it wheat or marijuana, has a substantial effect on supply and demand in the national market for that commodity."⁵

In considering the scope of the federal antitrust laws specifically, the Supreme Court examined the commerce requirements of the Clayton and Robinson-Patman Acts in Moore v. Mead's Fine Bread Company.⁶ The opinion discussed in dicta that while the victim is a local merchant, and no interstate transactions were used to destroy him, the beneficiary is an interstate business, the treasury used to finance the pricing warfare is drawn from interstate, and the prices on interstate sales were kept high while the local prices were lowered.⁷

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If this method of competition were approved, the pattern for growth of monopoly would be simple. As long as the price warfare was strictly intrastate, interstate business could grow and expand with impunity at the expense of local merchants. The competitive advantage would then be with the interstate combines, not by reason of their skills or efficiency but because of their strength and ability to wage price wars. The profits made in interstate activities would underwrite the losses of local price-cutting campaigns.⁸

But the Supreme Court later departed from this discussion in Gulf Oil v. Copp Paving and distinguished the reach of the Sherman Act from the Robinson-Patman and Clayton Acts.⁹ The Sherman Act¹⁰ prohibits conduct "in restraint of trade or commerce" so its commerce requirement can be met by wholly intrastate conduct if it substantially affects interstate commerce.¹¹ In contrast, the Robinson-Patman and Clayton Acts forbid certain acts by persons engaged "in commerce."¹² The Supreme Court explained that this distinct "in commerce" language "appears to denote only persons or activities within the flow of interstate commerce—the practical, economic continuity in the generation of goods or services for interstate markets and their transport and distribution to the consumer."¹³ Section 7 of the Clayton Act, which prohibits acquisitions that may substantially lessen competition, was subsequently expanded in 1980 to apply to persons engaged "in any activity affecting commerce."¹⁴

Indeed, the Department of Justice took advantage of the expanded scope of Section 7 to investigate a series of cannabis mergers in 2019.¹⁵ The series of cannabis second requests issued by the Department of Justice in 2019 signaled that the federal government can, and will, enforce antitrust laws in the cannabis industry, even if cannabis remains a Schedule I drug.

While federal antitrust claims should prove to be one important tool to ensure a level playing field, there are attributes of the cannabis industry structure that could prove challenging for plaintiffs under federal antitrust jurisprudence, e.g., pleading traditional relevant market definitions or market power where the regulatory landscape is complex and changing. For these reasons and others, cannabis could spur a renaissance in state unfair competition law.

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California Cannabis Looms Large

California, the largest state to legalize recreational marijuana, is also home to one of the country's most robust and comprehensive unfair competition laws, also known as the "UCL," or California Business and Professions Code §§ 17200 et. seq. A vast web of local ordinances and zoning restrictions governing California's cannabis industry offers plaintiffs numerous bases upon which to bring such claims against violating competitors and market participants. The UCL covers "any unlawful, unfair or fraudulent business act or practice and unfair, deceptive, untrue or misleading advertising."¹⁶

Plaintiffs also have California's False Advertising Law (FAL) and the California Legal Remedies Act (CLRA) at their disposal. The FAL broadly prohibits the advertising of goods or services using "any statement . . . which is untrue or misleading, and which is known, or which . . . should be known, to be untrue or misleading."¹⁷ California cannabis regulations similarly prohibit such marketing, including specifically with regard to health statements.¹⁸ The CLRA, on the other hand, prohibits "unfair or deceptive acts or practices" connected with the sale of goods or services.¹⁹ Violations include false advertising of goods, false or misleading statements regarding "price reductions," and misrepresenting the nature of a transaction.²⁰

To establish standing under any of these statutes, a plaintiff must demonstrate that they have "suffered injury in fact and . . . lost money or property" because of the defendant's unlawful act, though courts note that "injury in fact is not a substantial or insurmountable hurdle."²¹ While private actions under the UCL and FAL are limited to restitution and injunctive relief, the CLRA expressly states compensatory and punitive damages are available.

Finally, the state's licensing law, the Medicinal and Adult Use Cannabis Regulation and Safety Act (MAUCRSA) forbids geographic price discrimination for the purpose of injuring competitors or competition, price fixing, collusion, and predatory pricing behavior.²² A licensee shall not sell any cannabis or cannabis products below cost for the purpose of injuring competitors or misleading purchasers or give away any article or product for the purpose of injuring competitors or destroying competition.²³ And the pièce de résistance? Private plaintiffs can sue under MAUCRSA itself to recover monetary damages, relief not available under the UCL or FAL.²⁴

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Case law has not yet developed under B.P.C. § 26052 to define the elements of these violations, leaving room for a more expansive reading that may favor disadvantaged competitors. Could cost be interpreted to include cost of compliance, effectively making gray-market competitors (who are licensed but not compliant) liable and providing law-abiding licensees an opportunity to level the playing field? If private enforcement proves effective, perhaps the California...