Blunt Counsel on Marijuana Business Premises’ Leasing

Michael N. Widener

Your latest client, a commercial property owner, has an exciting representation proposal: Help her negotiate and draft a lease to a new marijuana business. You realize you’ve reviewed a few residential leases and drafted one or two simple commercial leases—but cannabis leasing isn’t familiar. Now what? This article offers a few simple tips.

Read the state bar opinions in your jurisdiction, and governing Supreme Court rules, to learn if it’s ethical to advise this client on cannabis business leasing. If so, then you can become the client’s trusted adviser if you engage in eight third-party conversations for risk-assessment.

Third Persons to Consult for Risk Assessment

The City or County Zoning Administrator. Does the tract’s zoning permit a cannabis business as a matter of right or only after obtaining use permits or variance relief? Why might relief be required? Local regulations manage things like separation of these businesses from “vulnerable population” uses and other providers of marijuana goods and services. Cities are trying to avoid clustering of these uses within their boundaries. If zoning provisions aren’t favorable, or the owner faces well-organized neighboring groups’ resistance, inform her that the entitlement odds are not good, but the high cost of navigating the zoning process is assured.

The Owner’s Secured Lender, if Applicable. First, though, carefully review the loan’s mortgage, deed of trust or like security instrument. Lately, more of these instruments prohibit property use that engages the cannabis industry. If that text appears, or if the text effectively says, “borrower shall comply with all applicable laws or regulations at any level of government,” the owner will need lender permission to lease. The lender may relent if enough controls over the tenant are implemented.

The Owner’s Banker. How will that bank receive, literally and figuratively, deposits from the owner derived from cannabis product sales? Marijuana businesses rarely have accounts in banks today because of FinCEN regulations regarding reporting as “suspicious activities” large cash deposits to the government. Financial institutions love deposits but hate audits by federal overseers and negative media coverage. In many states, therefore, the banking industry turns its back on cash deposits connected to the marijuana industry.

The Owner’s Liability Insurance Carrier. Will the owner’s premium costs increase for coverage against episodes involving the land or improvements resulting from a marijuana tenancy? Worse still, will the carrier cancel the owner’s coverage altogether? If there will be additional policy endorsements, what will these provide?

The Owner’s Property and Casualty Insurance Carrier. (See Owner’s Liability Insurance Carrier above.) These carriers fret about things like explosions from hash oil extractions or impacts from mold. Mold occupies center stage, especially in grow sites where high-water usage, heat and humidity are given.

The Owner’s Title Insurance Carrier. Some title companies have issued strange directives to agencies and escrow companies, full of ominous pronouncements. Some title companies preclude their agents handling escrows connected to cannabis businesses. Some exclude from coverage matters resulting from operating a cannabis-based business within the insured premises. Some companies threaten to “nullify” existing owner’s coverage if a marijuana business opens. How will your owner’s coverage be impacted?

The Property Management Company. This is if the premises are in a multibuilding commercial project, such as a shopping area. Larger scale projects, including buildings inside industrial or commerce parks, may be bound to restrictive covenants prohibiting “illegal businesses” or businesses inconsistent with “first class operations” within the project. Owners need to understand what these instruments require. Oftentimes owners don’t realize that restrictions, or even shopping center rules and regulations, prohibit marijuana sales or cannabis-product compounding, processing and so forth. It’s untidy to sign a lease only to be sued by the next-lot-over’s neighboring business or owner.

The Health Department. Do restrictions apply to aspects of a marijuana business’ operation? It’s unhelpful to sign a lease and open for business only to receive an agency citation or notice to cease operations in the leased premises. For instance, prohibitions or controls may affect using herbicides, pesticides or other toxic substances within an indoor grow site.

Other conversations may be needed. Consider other tenants’ rights in a multi-tenant building or center. Leases may contain language regarding quality or types of co-tenancies permitted, or that the landlord will comply with all applicable laws. Does your drug store tenant have a retail center exclusive to sell drugs? Does the market have an exclusive to sell all packaged “foods and beverages?” What, then?

What if several of the responses are negative, even menacing? That’s cause for earnest risk-assessment for both the owner and the prospective tenant. The tenant doesn’t want to be shut down, sued, or enjoined any more than does the landlord, especially after the tenant spends sums on interior improvements, equipment and fixtures, inventory and the like. A secured lender’s foreclosure threat represents “game over,” unless its corporate mind changes. An insurer informing the owner to expect loss of or reduction in coverage or escalating premiums can be determinative, unless the owner finds affordable substitute coverages. Essentially, it’s an occasion for expert analysis; and remember, Model Rule 1.1 requires counsel to be competent in these matters. Your client may need a specialized practitioners’ perspective. Don’t resist; an attorney’s incomplete or incorrect advice can be very costly.

Final thoughts: if you represent the landlord, counsel her to get personal guarantees from the cannabis business’ principals, preferably supported by an “evergreen” letter of credit for the full lease term. If you represent the tenant, advise it to resist sales talk about “premium rent for increased landlord risk.” Sophisticated landlords aren’t buffaloed; rent yield would have to be astronomical, or the landlord desperate for cash flow, to lease while faced with severe third-party pushback. Tenants instead should work closely with the landlord to surmount opposition and mitigate impacts of its tenancy, one issue at a time. Marijuana business tenants should anticipate bearing up-front costs of navigating these challenges.

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Michael N. Widener

Michael N. Widener heads Bonnett, Bonnett, Fairbourn, Friedman & Balint, P.C.’s real estate practice; he also is a zoning adjustment hearing officer in the City of Phoenix. He is the author of the book Joint Tenancies: Property Leasing in Cannabis Commerce, published by the American Bar Association.