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September 16, 2020 Top Story

Cannabis Contracts: Caveat Emptor?

Illegality prevents lost profits award for cannabis company

By Susan F. Dent

When the subject matter of a contract involves a Schedule 1 substance such as cannabis, federal courts cannot enforce performance or order remedies, one such court has held. In so ruling, the U.S. District Court for the District of Oregon highlighted an unexpected risk of contracting for cannabis-related services: a lack of federally enforceable remedies. Indeed, as the court raised this issue sua sponte, ABA Section of Litigation leaders and industry professionals alike agree that this ruling is a reminder to always consider the impact of inconsistent state and federal policies when counseling on cannabis industry matters.

The plaintiff argued the contractors provided subpar construction for their cannabis greenhouse

The plaintiff argued the contractors provided subpar construction for their cannabis greenhouse

Credit: contrastaddict | Photo editing by Genuine Pyun | iStockphoto by Getty Images

Breach of Commercial Contract with a Twist

In J. Lilly LLC v. Clearspan Fabric Structures International, Inc., a cannabis company signed an equipment lease agreement with a purchase option, as well as a separate construction contract, that provided that the defendant construction company would lease to the cannabis company a large greenhouse for the purpose of cultivating marijuana plants. The construction company entered into a contract with a subcontractor to construct the greenhouse for the cannabis company. The subcontractor allegedly performed subpar construction on the greenhouse, resulting in a myriad of leaks, holes in the roof, and ventilation system issues. After unsuccessfully attempting repairs, the cannabis company found the entire greenhouse unsuitable for housing a cannabis crop and moved forward with the instant litigation.

In its complaint, the cannabis company alleged breach of contract and breach of warranty against the construction company, with an added negligence claim against the subcontractor, and sought $5,400,000 in lost profits damages.

The construction company moved for summary judgment on the lost profit claim. The company posited two theories: first, the contracts at issue contained mutual waiver of damages provisions, and second, the cannabis company’s lost profit damages were too speculative.

The District Court’s Sua Sponte Issue-Spotting

While the court did analyze these two theories, it then did something else. Noting that neither the plaintiff nor the defendants raised the obvious issue of illegality of contractual subject matter, the court ordered all parties to brief the issue of whether a federal court sitting in diversity can award a party lost profits generated from the sale of marijuana.

Relying on both the Controlled Substance Act (CSA) and the Supremacy Clause of the U.S. Constitution, the court found that, under current federal law, it cannot.

Inconsistent State and Federal Policies

The court based its decision on several grounds. First, it reasoned that the CSA designates cannabinoids as a “Schedule 1” substance, and criminalizes its sale and surrounding activities in support of sale, such as those contemplated in the contracts at issue. Second, the court reasoned that the Supremacy Clause supports a finding that the CSA applies to, and is superior to, state law which may permit the sale and distribution of cannabis. Based on this reasoning, the court declined to enforce the cannabis-related contracts, holding that the CSA precluded any further enforcement of the contract at hand.

Remedies in Cannabis Contracts: What Now?

ABA leaders and industry attorneys agree that this ruling highlights an oft-overlooked issue in cannabis-industry contracts: legality of enforcement and availability of remedies upon breach. “I think this case will result in careful drafting,” opines Lisa J. Dickinson, Spokane, WA, cochair of the ABA’s TIPS Cannabis Law and Policy Task Force.

“This ruling is a perfect example of why special drafting considerations need to be taken into account when cannabis-industry contracts are being negotiated and entered into,” adds Jacqueline Z. Fox, Denver, CO, an ABA member who practices cannabis law. Rather, Fox opines, “the industry takeaway from this ruling should be to increase each respective party’s attention towards general cannabis contract-drafting strategies and to further push marijuana-related litigation towards state courts. Given the underlying nuances involved in various aspects of everyday matters within the cannabis industry, traditional boilerplate contracts are inherently susceptible to error.”

Will the court’s ruling in J. Lilly send a chilling effect through the cannabis industry? Industry attorneys are not convinced that it will, but remind those who are involved in drafting and litigating these contracts to review all potential risks with their clients before execution. Fox believes there are a number of drafting strategies that can minimize contract enforceability risks.

“First,” Fox opines, “you’ll want to include forum-selection and choice-of-law clauses for your respective state court. This ensures that litigation stays in marijuana-friendly state court, thus reducing the possibility of federal courts sua sponte raising unclean hands or other federal illegality issues.” Second, Fox continues, “include a severability clause. Even if a court finds your provision compels violation of the CSA, the remainder of the contract will still remain in effect, thus providing the opportunity for other means of recovery.” As a third and final reminder, Fox encourages attorneys to “engage in creative drafting. This can include practices such as piecemeal drafting that clearly delineates each service with separate consideration for each service.”

“There are always intricacies with contract drafting,” Dickinson adds. “The arena for litigating these clauses is wide open right now, and I look forward to seeing the law evolve accordingly.”


Susan F. Dent is a contributing editor for Litigation News.

Hashtags: #Contract, #CannabisLaw, #SupremacyClause

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