Litigation in the Weeds

In States Where Marijuana Is “Legal,” What’s the Risk?

As marijuana businesses become legal in more states each year, an emerging new area of litigation has arisen. The intricacies of litigating or drafting deals where the subject matter is federally illegal but the business itself may be allowed by state law are treacherous at best. Further, what is the risk to a firm that practices in multiple states when the laws may disallow the business in one state but allow it in another? Is it ok to advise on a commercial lease or insurance for a marijuana grower or retail operation or not? Is it ok to advise on how to obtain a marijuana license or federal trademark?

The answers are that we don’t know yet, and it depends. Until more of these cases are heard, case law is sparse at best. One case that may serve as a cautionary tale is the story of attorney Jessica McElfresh out of San Diego who was charged with violating civil RICO law and a felony when assisting a marijuana business client. Prosecutors alleged that the business owner and others had conspired to illegally manufacture and distribute hash oil across the country. The issues at stake involved seizure of her attorney-client communications with the client. She has since pled to an infraction, but the felony charges were dropped with the stipulation that she not break any laws for a year. During her case, recreational marijuana sales became legal, but prosecutors did not dismiss the charges against McElfresh.

Some state bar associations have acted progressively to protect their attorneys. Colorado and Washington were among the first states to specifically allow attorneys to advise and assist marijuana clients with their legal matters. Washington first allowed practice in this area through a comment to its RPC 1.8; however, the state’s position was based on the issuance of the “Cole Memorandum,” which was a guidance to federal prosecutors to stand down on enforcement. Since then, the federal government has revoked the Cole Memorandum, so rules based on that guidance need to be changed. Washington is in the process of amending its rules since the revocation. Practitioners in other states have proceeded by petitioning their supreme courts with rule changes (rather than a comment to the existing rules) to allow attorneys to advise and consult with marijuana businesses. And finally, some states specifically disallow the practice of attorneys giving advice to marijuana businesses. In short, a review of your state’s ethics rules is the first thing to do when determining whether to advise a client or not about issues involving marijuana.

Beware of Pitfalls and Unforeseen Issues

So, once you determine that you want to represent a client on a cannabis-related issue, what next? Many issues facing marijuana businesses are like those confronting any other business. However, beware of pitfalls for the nonexperienced attorney in this area. Generally, leases may contain clauses permitting the eviction of a tenant for any illegal business. Obviously, careful drafting can circumvent this problem, but counsel must look for those issues when a client seeks advice after signing a lease. Insurance is also an issue. Questions have arisen over whether or not cannabis plants can be insured against loss. What else is covered? What are the other coverage issues that may arise? Furthermore, do you want an arbitration clause in your operating agreement, even if you aren’t sure what arbitrators will hear a dispute on this type of issue? Is it better to just go to court in a dispute? Will you need to know how to appear before an administrative tribunal if your client has a license violation or revocation hearing? What will happen in a state trademark dispute (as most companies have not been able to obtain a federal trademark)? What about ancillary businesses—landlords, packaging and machinery manufacturers, retail “swag” or merchandise stores, advertising agencies, accountants, and doctors or naturopaths who prescribe medical marijuana? Another issue that has newly arisen: Employees of marijuana businesses are having difficulty getting loans because certain banks and credit unions will not accept their W2 from a marijuana business as proof of legal income.

When counseling a marijuana client, many potentially unforeseen issues arise each day. The best thing one can do is to stay up to date on national trends and case law as well as trends in the industry. The laws also are generally state-specific, as is their enforcement. Each state will deal differently with this emerging area of law.

One example: When one state’s legislature made medical marijuana “legal,” the local U.S. attorney decided to “raid” businesses that sold medical marijuana in that jurisdiction and shut them down for being federally illegal. In addition, letters were sent to landlords stating that they could be charged in a conspiracy if they rented to medical marijuana businesses and that they must evict those entrepreneurs. What if your client was stuck in a commercial lease with no escape clause? Would they be liable for the entire lease term? Such a scenario also could occur if the federal government changes its enforcement policies and decides to get in a fight with a state. To date, there has been no test case on this issue, but we all are aware of federal preemption.

Litigation of Marijuana-Related Issues

As this article is written, very few cases have litigated marijuana issues. Most of the cannabis cases I have dealt with are partnership disputes. Because some of these businesses were formed without the advice of an attorney, especially in “first to file” or “lottery” states, their records can be murky at best.

Basically, dissenting members tend to have to sue when a disagreement or deadlock arises. The pitfalls of initiating legal action are that when you point the finger at your partner for breaches of fiduciary duty, you risk having the regulatory agencies investigate your allegations and cancel your license. If that occurs, it’s all for naught, as there will be no business to save. When you finally “pull the trigger” and file suit against a partner/member, the suing partner must be aware that the business’s license may be revoked, or that he or she would be forced to file declarations admitting to things such as basic violations of federal law and other unpleasant facts. It is sometimes difficult to obtain a protective order just for embarrassing disclosures. One of my first cases resulted in “Exhibit A”: a picture of $400,000 on the conference room table. Because banks and credit unions did not accept marijuana businesses, all businesses dealt in cash. The judge refused to issue a protective order in the matter. And when do you counsel your client to plead the fifth? Most civil lawyers are not well versed in criminal law. As these are issues to consider before filing suit, many disputes avoid litigation and are settled before an action is filed.

How Do I Prepare to Practice in This Area?

So, should your firm leap into representing marijuana clients or assisting ancillary ones? To avoid doing so puts you behind the ball as other attorneys and firms potentially will swoop up the emerging businesses. Is it worth the gamble? From an ethics perspective, the decision is somewhat murky. You should first seek out an opinion from your state bar. The states that have firm rules for the protection of attorneys counseling clients in this area seem to be the safest. Avoid states or districts where you have outspoken law enforcement or prosecutors who oppose these types of businesses. Keep copious notes and records. One of the first things you must do when rendering advice to a marijuana client is to inform them that you are counseling them under state law, and that what they are doing remains federally illegal. Keep up to date on the law and ethics rules, along with federal policy and trends. Many attorneys and firms are experiencing no problems as they delve into the representation of marijuana clients. But the reason could be that, thus far, no one has chosen to enforce ethical rules or laws against them. In short, some level of danger still exists, along with a stigma of practicing in this emerging area.

At this point, cannabis is one area of the law for which it’s still the wild, wild west. I appreciate TIPS and Chair Roy Cohen for forming a task force on cannabis to examine these challenging issues, and to stay apprised of the trends in this fast-growing legal arena.