Commercial Leases Involving Cannabis Businesses A Practical Guide for Landlords and Their Counsel, 0321 COBJ, Vol. 50, No. 3 Pg. 42
Author | BY BEN LEONARD AND BRETT WILLIAMS |
Position | 50, 3 [Page 42] |
REAL ESTATE LAW
BY BEN LEONARD AND BRETT WILLIAMS
As the cannabis industry continues to grow in Colorado, commercial landlords and their counsel will encounter tenants with cannabis-related businesses more frequently. This article addresses issues unique to these lease transactions and offers suggestions for structuring such leases to maintain regulatory compliance.
The
prolific rise of the cannabis
This
article explores the cannabis legal landscape as it relates
to commercial landlords in Colorado. It addresses factors
landlords should consider before entering the cannabis space,
offers suggestions for structuring lease provisions in the
cannabis industry context, and discusses the potential impact
of Internal Revenue Code (IRC) § 280E on property
owners.
General Considerations for Landlords
Leasing to cannabis operators can benefit landlords, but before jumping in with both feet, real estate owners should weigh these benefits against the inherent challenges of such an arrangement.
Opportunities
Above
all, landlords stand to benefit from charging a premium on
rent. This is often justified by the increased risks the
landlord assumes by leasing to a cannabis operator. It's
also driven by supply and demand. Landlords can often charge
a higher base rent where there's greater competition for
properties that satisfy the licensing requirements. In
Colorado, local jurisdictions can regulate the time, place,
and manner of cannabis operators, so they may implement
zoning and setback requirements unique to marijuana
operations.
Further,
depending on the local jurisdiction, the tenant may be
required to make substantial improvements to the property to
obtain its license, including bringing the property up to
code and implementing security measures.
Challenges
Despite
the attractions to the cannabis industry, cannabis-related
leasing arrangements also present property owners with unique
challenges. First and foremost, landowners should be aware
that conventional lending is largely unavailable to the
cannabis industry at the present time due to marijuana's
status as a Schedule I drug under the federal Controlled
Substances Act (C SA).
Property owners with existing financing should review their loan documents before leasing to cannabis tenants to ensure that entering into a proposed lease will not cause the loan to go into default. Virtually all commercial loan agreements contain a provision requiring borrowers to comply with all applicable laws. And unless a lease agreement is specifically drafted to be used in connection with a cannabis operation, there is unlikely to be a necessary carve-out from such covenant for federal laws prohibiting the trafficking of cannabis (discussed below). Thus, entering into a lease where the subject property will be operated for a federally illegal purpose requires attention to the landlord's financing documents.
Other
challenges relate to the general nature of the cannabis
tenant. For example, the tenant's revenue stream is
somewhat uncertain; a tenant who loses the required licenses
to operate also loses the revenue needed to pay rent.
Moreover, cannabis operators do not currently have access to
federal bankruptcy protection, which can make it more
difficult for them to liquidate assets and pay
creditors.
There
are a few considerations involving federal law that may
directly affect landlords. As discussed in more detail below,
the Internal Revenue Service might attempt to apply IRC
§ 280E to landlords with business income and expenses
related to the cannabis industry.
Navigating the Legal Landscape
In
Colorado, the implementation, management, and enforcement of
the state's regulatory scheme is relegated to the
Colorado Department of Revenue, Marijuana Enforcement
Division (MED). The MED oversees the industry at the state
level and is responsible for issuing business licenses,
vetting potential licensees, and monitoring licensees'
activities. But Colorado has a dual-licensing system that
requires marijuana businesses to also be approved to operate
by the applicable local jurisdiction.
An Overview of State Regulations
The type of a person's or entity's economic interest in a cannabis-related business determines the level of disclosure required to the MED and the level of scrutiny the MED will apply to vet such person or entity for a state license. Economic interests in a marijuana business generally fall into two categories: (1) equity holders and those who receive a share of the company's revenue, and (2) counter parties to contracts with the business.
Equity
holders are further delineated by the business percentage
they hold and/or their ability to control the licensed
business into two groups—controlling beneficial owners
(CBOs) and passive beneficial owners (PBOs). CBOs have a 10%
or greater stake in the company and/ or are in a position to
control the business.
For purposes of this regulatory analysis, "control" is defined as "the possession, direct or...
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