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Stanley S. Jutkowitz
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Avrohom Colev Posen
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Stanley S. Jutkowitz
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§ 1.1 Introduction
Laws and regulations relating to cannabis and the cannabis industry continue to evolve at a rapid pace. In order to put current developments in context, it is important to understand the current state of the law regarding marijuana and hemp.
The starting point is the Controlled Substances Act, 21 U.S.C. § 801 et. seq. (“CSA”), passed in 1970 to regulate the manufacture, use, and distribution of certain controlled substances for medical, scientific and industrial purposes and to prevent these substances from being used for illegal purposes. The CSA classified various drugs and chemicals into five categories, or schedules. Marijuana, along with heroin, cocaine, LSD, and other substances, was placed on the most restrictive schedule, Schedule 1. The CSA prohibits the manufacture, distribution, sale possession, or use of marijuana. Also, the CSA operates to prohibit the transportation of marijuana across state lines, even between states that have passed laws legalizing marijuana, as well as international borders.
Despite the existence of the CSA, as of today, thirty six states plus the District of Columbia, Guam, Puerto Rico, and the U.S. Virgin Islands have laws legalizing marijuana for medical use, and fifteen of those states, plus D.C., and Guam a have legalized marijuana for recreational use, as well. Legislation to legalize marijuana is currently working its way through other state legislatures. Since the CSA is the law of the land, how states can “legalize” marijuana consistent with the preemption doctrine is complicated. _____.
The laws relating to marijuana and hemp became very complicated at the end of 2018, with the passage of the Agricultural Improvement Act of 2018, the Farm Bill. It is important to understand that both hemp and marijuana come from the same species of plant, Cannabis sativa L., and both were included in the definition of marijuana in the CSA. Both marijuana and hemp contain a number of chemical compounds, the two most known of which are THC (the psychoactive compound) and CBD. The legal difference is that hemp contains less than three percent THC. Part of the confusion revolves around the other chemical compound, CBD, which is extremely popular and ubiquitous in the market place. CBD comes from both hemp and marijuana. Further complicating the situation is that there is no standard for measuring THC content in a cannabis plant, so what might be classified as hemp by one state might be classified as marijuana by a different state.
While hemp is technically legal under federal law, the Food and Drug Administration maintains jurisdiction over hemp (and therefore CBD) to the extent it is marketed as a food or dietary supplement or as a drug. Also, the state statutory and regulatory framework for hemp and CBD derived from hemp remains very confusing and is rapidly evolving.
This section will focus on recent developments in cannabis law.
§ 1.2 Tax Issues for the Cannabis Industry
Richmond Patients Group v. Commissioner of Internal Revenue, T.C. Memo 2020-52
Date: May 4, 2020
Facts: Plaintiff operated a medical marijuana dispensary. It purchased for resale bulk marijuana and inspected, sent out for testing, trimmed, dried, packaged, and labeled the marijuana it purchased. It did not grow marijuana or sell live plants, clones, or seeds. Plaintiff took business expense deductions for compensation to officers, salaries and wages, repairs and maintenance, rents, taxes, and license fee. Plaintiff argued that it was a producer, not a reseller and therefore should be able to include in cost of goods sold (COGS) certain indirect inventory costs pursuant to regulations issued under Internal Revenue Code (Code) section 471.
Held: Plaintiff was a reseller, not a producer and therefore not able to deduct certain indirect inventory costs included in COGS and plaintiff was not able to deduct certain business expenses.
Reasoning: The plaintiff argued that it was a producer for purposes of sections 471 and 263A of the Code and should be entitled to deduct or include in COGS certain indirect inventory costs. The Court analyzed the definition of what it means to produce and found that constructing, building, installing, manufacturing, developing, improving, creating, raising, or growing were activities of production. Plaintiff did none of those things and was therefore a reseller, not a producer.
In denying a deduction by the Plaintiff for certain business expenses, the Court cited Code section 280E which denies a deduction of any business expenses related to a business consisting of trafficking in a controlled substance. A marijuana dispensary is such a business. The Court then analyzed whether such business expenses could be included in COGS. The Court noted that Section 263A includes in COGS only business expenses that are otherwise deductible and since 280E prohibits these expenses from being deductible they could not be included in COGS. This case is one of a long line of cases in which the Internal Revenue Service has successfully argued against taxpayers seeking to plan around section 280E.
Wakefield v. Department of Revenue, State of Oregon (unpublished) 2020 WL 905739 (Or. Tax Magistrate Div.)
Date: February 25, 2020
Facts: Plaintiff operated a medical marijuana business in Oregon. Plaintiff filed its 2014 and 2015 Oregon income tax returns reporting certain business expenses. The Oregon Department of Revenue disallowed Plaintiff’s business expenses citing Code section 280E. The issues was whether the Plaintiff could deduct its business expenses due to Code section 280E since Oregon income tax law generally follows federal tax law.
Held: Plaintiff was not eligible to deduct certain business expenses in 2014 but was able to do so in 2015 based on a state measure, Measure 91, that was approved in 2015 that made Code section 280E inapplicable to computation of state income taxes.
Reasoning: Plaintiff argued that Measure 91 which became effective on July 1, 2015 for tax years beginning on January 1, 2015, should be retroactively applied to the 2014 tax year. The version of the statute that implemented Measure 91 was modified and the earlier version of that statute was deleted and Plaintiff argued that this rendered the effective date ambiguous. The Oregon Tax Magistrate Division ruled that based on the Oregon constitution, statutes, and case law the effect of deleting a statute that was superceded by an amended version of the same statute did not have the effect of altering the effective date. Accordingly, the Plaintiff could not take business deductions prohibited under 280E prior to the date it was decoupled from Oregon law. This case illustrates the complexities of dealing with the impact of section 280E under federal and state tax law. A careful analysis of the impact of Code section 280E on a cannabis business is essential both for ongoing business planning as well as for an M&A transaction.
§ 1.3 Trademarks
Kiva Health Brands LLC v. Kiva Brands Inc., 439 F. Supp.3d 1185 (N.D. Cal. 2020)
Date: February 14, 2020
Facts: Plaintiff started using KIVA trademark in connection with natural foods starting in 2013 and obtained a registration in 2014. Defendant started using KIVA trademark in connection with cannabis infused chocolates starting in 2010. Plaintiff allegedly first learned of Defendant’s use of the same mark in June 2015. Plaintiff brought suit for trademark infringement in 2018. Among other things, Defendant asserted laches and prior use as affirmative defenses to infringement. Both parties moved for summary judgment on these defenses.
Held: Summary judgment against laches defense denied. Summary judgment against prior use defense granted.
Reasoning: Laches defense. The principle behind laches is that a court should not help a plaintiff who sleeps on its rights. To establish laches, a defendant needs to show unreasonable delay and prejudice. A plaintiff’s delay is the time between: (a) the date it knew, or in the exercise of reasonable diligence, should have known about its potential cause of action; and (b) the date it brings suit against the defendant. A delay cannot be reasonable if it is longer than the analogous statute of limitations, which in this case, the court held was four years. Here, Plaintiff brought suit in 2018, claiming to have first learned of Defendant’s use of the KIVA mark in 2015 (within the statute of limitations period). Defendant, however, showed evidence of its use online, including on its website and on Facebook as early as 2013 (outside the statute of limitations period). Thus, summary judgment was denied because there was a genuine dispute as to the period of Plaintiff’s delay and whether it was even capable of being deemed reasonable.
Prior use defense. In a prior decision on a motion for preliminary injunction, the court held that Defendant’s prior use defense was not likely to succeed under the Lanham Act, 15 U.S.C. § 1115(b)(5) because its use—in connection with cannabis infused chocolates—was illegal under federal law. The court restated its reasoning from that opinion in this one: “To hold that [Defendant’s] prior use of the KIVA mark on a product that is illegal under federal law is a legitimate defense to [Plaintiff’s] federal trademark would put the government in the anomalous position of extending the benefits of trademark protection to a seller based upon actions the seller took in violation of that government’s own laws.” (citation and internal quotation marks omitted). (Author’s view: The court’s reasoning is questionable for multiple reasons, including because it denied summary judgment on the laches defense. If the federal illegality of Defendant’s use would bar a prior use defense, there is no reason why it would not also bar a laches defense.)
Given the court’s earlier decision denying prior use as a defense under Section 1115(b)(5), Defendant this time relied on Section 1065 of the Lanham Act, which expressly provides for a prior use defense based on trademark rights established under state law. The court did not dispute Defendant’s interpretation of Section 1065’s language or suggest that Defendant’s prior use defense would not be available thereunder. But the court dismissed Defendant’s position as inapposite because Section 1065 concerns “incontestable” marks, which Plaintiff’s mark is not, and granted summary judgment to Plaintiff on Defendant’s prior use defense. (Author’s view: The court’s reasoning is questionable. Marks that have obtained incontestable status are afforded even greater protections under the Lanham Act than marks that have not. See 15 U.S.C. § 1115(b). By seemingly making prior use of cannabis marks a viable defense to incontestable marks but not contestable marks, the court gave greater protections to contestable marks. That does not square with the Lanham Act.)
BBK Tobacco & Foods LLP v. Skunk Inc., No. CV-18-02332-PHX-JAT, 2020 WL 1285837 (D. Ariz. March 18, 2020)
Date: March 18, 2020
Facts: Plaintiff brought suit against Defendant for infringing certain federally registered SKUNK-formative marks. Defendant counterclaimed seeking to cancel Plaintiff’s SKUNK registration for “herbs for smoking” on the grounds that SKUNK is generic for cannabis, which is an herb for smoking. Plaintiff moved to dismiss the counterclaim.
Held: Motion to dismiss counterclaim granted.
Reasoning: The court found that the USPTO’s policy is to refuse registration of marks used for unlawful goods, such as cannabis, and noted the USPTO’s refusal of several registrations for cannabis-based goods. The court therefore concluded that the “herbs for smoking” identified in Plaintiff’s SKUNK registration could not have been a reference to cannabis. The court also noted that “a trademark registration is not susceptible to a genericness challenge simply because it is the generic name for something; rather, it must be the generic name for the particular goods listed in the trademark registration.” Here, even if skunk is generic for cannabis, cannabis is not one of the goods listed in Plaintiff’s registration. Accordingly, Defendant’s counterclaim seeking dismissal of SKUNK on the basis that skunk is generic for cannabis failed to state a claim upon which relief could be granted.
Clint Eastwood v. Sera Labs, Inc., et al., Case No. 2:20-cv-06503-RGK-JDE, 2020 WL 5440564 (C.D. Cal. July 28, 2020)
Date: July 28, 2020
Facts: Advertising claimed that Defendant’s CBD product was put out by Clint Eastwood. Advertising included fabricated interviews with Mr. Eastwood. Eastwood sought a TRO and preliminary injunction based on false advertising, violation of common law right of publicity, false endorsement under the Lanham Act, and various other related claims.
Held: TRO granted.
Reasoning: Defendants had zero relationship with Clint Eastwood. All advertising was completely fabricated. Defendant Sera Labs submitted a declaration explaining that the advertising was created and disseminated by others without approval from Sera Labs. On that basis, the court agreed to exclude Sera Labs from the TRO, but acknowledged that such a finding would not preclude its potential liability.
§ 1.4 False Advertising
Snyder v. Green Roads of Florida LLC, 430 F. Supp.3d 1297 (S.D. Fla. January 3, 2020)
Date: January 3, 2020
Facts: Defendant sells various CBD products. Plaintiff sues for false advertising and related laws on the theory that labels overstate the CBD content. Defendant moved to stay under the primary jurisdiction doctrine.
Held: Motion to stay granted.
Reasoning: Courts consider four factors when applying the primary jurisdiction doctrine: (1) the need to resolve an issue that (2) has been placed by Congress within the jurisdiction of an administrative body having regulatory authority (3) pursuant to a statute that subjects an industry activity to a comprehensive regulatory scheme that (4) requires expertise or uniformity in administration. Courts also consider and rely heavily on a fifth factor implicating FDA jurisdiction: whether the FDA has shown any interest in the issues presented by the litigants. Here, the court determined that the primary jurisdiction doctrine was applicable because there is a need for consistent guidance on CBD labeling standards, Congress has placed the authority with the FDA via the Farm Bill, and the FDA, which has expertise and will ensure uniformity in administration, is in the midst of working on the issue.
Potter v. Potenetwork Holdings, Civil Action No. 19-24017-Civ-Scola, 2020 WL 1516518 (S.D. Fla. March 30, 2020)
Date: March 30, 2020
Facts: Defendant sells various CBD products. Plaintiff sues for false advertising and related laws on the theory that labels overstate the CBD content. Defendant moved to stay under the primary jurisdiction doctrine.
Held: Motion to stay denied.
Reasoning: The court determined that the primary jurisdiction doctrine was not applicable here because the FDA’s forthcoming guidance and regulations on the labeling of CBD products is unlikely to affect the outcome of a case concerning the truth or falsity of the content claim at issue.
Colette et al. v. CV Sciences, Inc., 2:19-cv-10227-VAP-JEM(x), 2020 WL 2739861 (C.D. Cal. May 22, 2020)
Date: May 22, 2020
Facts: Defendant sells various CBD products. Plaintiff sues for false advertising and related laws on the theory that she would not have purchased the products if she had known they were not legally sold in the U.S. Defendant moved to stay under the primary jurisdiction doctrine.
Held: Motion to stay granted.
Reasoning: The court determined that the primary jurisdiction doctrine was applicable in this case because the FDA is in the process of regulating the products at issue and there is uncertainty with respect to how the products will be classified, the types of labelling that will be required, etc. The court was also concerned that because there are multiple similar litigations pending, proceeding in any of them without the benefit of the FDA’s ultimate guidance likely would result in inconsistent rulings. The court also distinguished this case from others where FDA guidance would not affect the outcome, and there was no danger of inconsistent rulings.
Glass v. Global Widget, LLC d/b/a Hemp Bombs, No. 2:19-cv-01906-MCE-KJN, 2020 WL 3174688 (E.D. Cal. June 15, 2020)
Date: June 15, 2020
Facts: Defendant sells CBD-infused edibles, capsules, oils, and vape products. Defendant’s advertising represented that its products were legal and, according to Plaintiff, that they contain between seven and 82% more CBD than is actually present in the products. Plaintiff brought suit for false advertising and related claims. Defendant, among other things, moved to stay based on the primary jurisdiction doctrine.
Held: Motion to stay granted.
Reasoning: Piggybacking on Collette case, the court held that the FDA’s activities in clarifying its position on CBD warranted a stay.
Ahumada v. Global Widget, Case No. 19-cv-120005-ADB, 2020 WL 5669032 (D. Mass. August 11, 2020)
Date: August 11, 2020
Facts: Defendant sells various CBD products. Plaintiff sues for false advertising and related laws on the theory that labels overstate the CBD content and falsely convey legality. Defendant moved to stay under the primary jurisdiction doctrine.
Held: Motion to stay granted.
Reasoning: The court determined that the primary jurisdiction doctrine was applicable in this case because the FDA is in the process of regulating the products at issue and there is uncertainty with respect to how the products will be classified, the types of labelling that will be required, etc. The court was also concerned that because there are multiple similar litigations pending, proceeding in any of them without the benefit of the FDA’s ultimate guidance likely would result in inconsistent rulings.
Ballard v. Bhang Corp., Case No. EDCV 19-2329 JGB (KKx), 2020 WL 6018939 (C.D. Cal. Sept. 25, 2020)
Date: September 25, 2020
Facts: Defendant sells “medicinal chocolate,” which claims to have certain amounts of THC and CBD. Plaintiff’s independent lab testing revealed that Defendant’s chocolate did not contain the amount of CBD advertised. Plaintiff therefore filed a class action lawsuit for false advertising and related claims. Among other things, Defendant moved to stay based on the primary jurisdiction doctrine, and dismiss based on preemption.
Held: Motion to stay based on primary jurisdiction denied. Motion to dismiss based on preemption denied
Reasoning: Motion to stay. Defendant argued that FDA regulations concerning CBD safety, including how to measure and label cannabinoid content, was forthcoming, and that the court should therefore defer consideration of the CBD claim until after such guidance was issued under the primary jurisdiction doctrine. The court denied the motion because FDA guidance would not clarify the straightforward issue of whether the amount of advertised CBD was true or false. The court distinguished other cases that had granted stays pending FDA guidance on the theory that such guidance would clarify an issue, such as the legality of CBD, or the meaning of “hemp extract.” The court reasoned that no such clarity was needed here, as this was not a case that involved a “definitional agreement” or required “the FDA’s technical expertise.”
Motion to dismiss. Defendant’s motion to dismiss was based, in part, on its argument that the 2018 Farm Bill granting the FDA authority to regulate cannabinoids in food products preempted Plaintiff’s stated false advertising claims. The court denied the motion because nothing in the Farm Bill purports to preempt state tort laws, and state false advertising laws do not conflict with or impede the 2018 Farm Bill. The court, however, ultimately granted Defendant’s motion to dismiss, with leave to amend, because Plaintiff’s complaint failed to identify basic information, including the specific chocolates he bought, when he bought them, how they were advertised, and how they fell short of that advertisement.
§ 1.5 Bankruptcy
In re Malul, 614 B.R. 699 (Bankr. D. Colo. 2020)
Facts: Several years after the debtor’s Chapter 7 case was closed, the debtor filed a motion to reopen the case in order to disclose her interests in what was then a non-operational medical marijuana company and pending state court lawsuit against the company’s principal. The motion was granted and after entry of order reopening the case, the debtor filed an amended schedule of assets and a motion to compel abandonment of her interests in the company and the lawsuit. The Chapter 7 trustee filed a motion to settle the debtor’s claim in the state court action. The United States Trustee filed a motion to vacate the order conditionally reopening the case and to return the parties to the status quo ante.
Held: The Bankruptcy Court granted the motion to vacate, vacated the Order reopening the case, and then denied the Motion to Reopen. It also directed the parties to take all actions necessary to re-establish the status quo ante.
Reasoning: The Bankruptcy Court reasoned that under the Controlled Substances Act (CSA), which preempted state law in this instance, it was illegal to use, sell or cultivate marijuana. Any contract relating to the sale, use, or cultivation of marijuana was in contravention of public policy and therefore void and unenforceable. The Court pointed out that any such contract was also illegal and unenforceable under Colorado law.
The debtor argued that the company had no assets and operations and was therefore no longer a marijuana business. The Court found, however, that despite the fact that the company had no assets or operations, the debtor’s interest in the marijuana company was illegal ab initio and ownership of an interest in the company constituted an ongoing violation of the CSA. Furthermore, the Court found that the lawsuit involved a loss of profits from an illegal business. Following a long line of bankruptcy cases, the Court found that reopening the case would require the Court to deal with an illegal asset in violation of Federal laws. In rendering its decision the Court noted that “participants in the marijuana industry will continue to experience difficulty and uncertainty in predicting the outcome of any song marijuana-related bankruptcy case unless and until Congress provides a legislative solution to the divergent federal and state drug laws.” The Court may enjoy the opera, but anxiously awaits the fat lady’s song.
§ 1.6 Real Estate
§ 1.6.1 Zoning
SEVEN HILLS, LLC, et al., Appellants, v. CHELAN COUNTY, Respondent, Case No. 36439-9-III, Unpublished Opinion Filed April 23, 2020.
Facts: Washington State voters approved Initiative 501 in 2012 to decriminalize most marijuana production and use in the state. Chelan County passed a moratorium on the siting of marijuana facilities in September 2015, and in February 2016, banned marijuana production and processing permanently in Chelan County. Appellant received four citations in September 2016, for manufacturing marijuana in violation of the local Chelan County ban on cannabis production and for operating without proper permits. Chelan County, in March 2017, then ordered Appellant to cease marijuana production and processing, and to remove all plants, growing structures, and propane tanks from the premises. Appellant alleged that they had a vested right to produce marijuana because they began operating legally prior to the enacted moratorium. They challenged the citations and the order to the county hearing examiner, who affirmed, and to the Chelan Superior Court, which did the same. Seven Hills then appealed to the Court of Appeals of Washington, Division 3.
Held: The Court of Appeals affirmed the decisions of the county hearing examiner and the Chelan Superior Court, ruling that Appellant did not establish that it had a valid nonconforming use, as it was not legally operating its production business prior to the moratorium established in September 2015.
Reasoning: While the appeal to the Court of Appeals raised two primary areas of challenge, the Court found Appellant’s arguments regarding the burden of proof at the administrative hearing and deficiencies regarding the county hearing examiner’s lack of legal citations to be without merit. When addressing the issue concerning Appellant’s alleged nonconforming use of the property, the Court analyzed the timeline of Appellant’s activities. In order to establish a nonconforming use despite local zoning ordinances, the use must lawfully exist, and continuously be maintained, prior to enactment of the regulation restricting such use. Here, the Court found that Appellant’s actions prior to the passing of the moratorium in September 2015 were not sufficient to establish a legal nonconforming use. Appellant claimed that the applications filed and permits obtained from the Chelan County officials in advance of the moratorium were in pursuit of the development and construction of marijuana production and processing facilities. However, the Washington State Liquor and Cannabis Board (WSLCB) first issued a license to Seven Hills to produce and process marijuana on January 26, 2016, two weeks prior to the passing of the permanent ban, but nearly four months following the temporary moratorium. The Court found that marijuana production remains illegal in Washington State absent permission from WSLCB to produce it. Therefore, Appellants actions prior to the issuance of the WSLCB permit could not sufficiently establish a legal nonconforming use of the property once the moratorium was enacted.
§ 1.6.2 Geographical Restrictions
TOP CAT ENTERPRISES, LLC, Appellant, v. CITY OF ARLINGTON, et al., Respondents, Case No. 79224-5-I, Opinion Filed: January 6, 2020. 11 Wash.App.2d 754 (Court of Appeals of Washington, Division 1).
Facts: The Washington State Liquor and Cannabis Board (WSLCB) was the agency tasked with awarding the retail licenses in Washington State following the approval of Initiative 501 in 2012. Licenses were initially granted using a lottery system and were assigned to specific jurisdictions. In 2015, with the passing of the Cannabis Patient Protection Act (CPPA), the number of available licenses increased by 222, but were awarded to applicants using a priority rating system (based on skill, experience, and qualifications in the marijuana industry). The CPPA also allowed certain previously awarded lottery licenses with jurisdictional limitations to transfer to other jurisdictions, but only once their WSLCB licensing approval process was complete and if an open spot remained in their desired target jurisdiction. Top Cat was a lottery winner that was unable to open in its initial jurisdiction due to a local moratorium. On December 8, 2015, 172nd Street Cannabis received its initial CPPA designation and sought the last available retail license in Arlington for a retail location. They sought to operate at a leased property located at 5200 172nd St., in Arlington, which was identified as lot 500B on the larger Arlington Municipal Airport property. On January 29, 2016, Top Cat applied to move its license to Arlington, but WSLCB then subsequently approved and issued the only available license to 172nd Street, before completing a final inspection of Top Cat’s application. Top Cat requested an administrative hearing before an Administrative Law Judge (ALJ) alleging that the 172nd’s leased property violated the CPPA requirement prohibiting marijuana retail locations within 1,000 feet of “the perimeter of the grounds of” a school, since Weston High School leases lot 301 from the Airport as well. The ALJ concluded that the measurement of 1,000 feet was to be calculated from the edge of the leased premises, not the larger Airport parcel. The Snohomish County Superior Court then affirmed the order and Top Cat appealed to the Court of Appeals of Washington, Division 1.
Held: The Court of Appeals agreed with the conclusions of the ALJ and WSLCB, finding that the ordinary meaning of “property line” should apply, which in this case was interpreted to mean that the distance should be measured from the line separating a lot from other adjoining lots or streets, not the edge of the larger parcel containing the lot.
Reasoning: The Court of Appeals of Washington stated that they interpret agency regulations as if they were statutes, but reviews an agency’s legal determinations de novo (but with substantial weight to an agency’s interpretation of statutes and regulations within its area of expertise). Under I-502, the WSLCB is prohibited from issuing “a license for any premises within one thousand feet of the perimeter of the grounds of any elementary or secondary school.” In the WSLCB regulations, the language included additional text providing that “The distance shall be measured as the shortest straight line distance from the property line of the proposed building/business location to the property line of” the prohibiting entity. Top Cat argued that “property line” should be understood as a legal description from a deed setting forth the boundaries of real property for the lot overall, which, they alleged, put the 172nd Street Cannabis’s location only 120 feet from the school property (because the Airport property is immediately diagonal from the proposed retail store). However, the Court of Appeals of Washington, agreeing with the prior decisions, confirmed that the 1,000 foot separation requirement must follow the plain meaning and should use the leased lot lines when calculating the distance. They concluded that the WSLCB’s measurement finding a 1,600 foot separation between the retail location and the school was consistent with the statute, the legislative intent and the plain meaning, thereby affirming the approval of 172nd Street Cannabis’ license.
