By Daniel Bugbee & Dominique Scalia
While all burgeoning industries struggle to obtain financing, the recreational marijuana industry faces even steeper challenges due to both the potential impacts of federal regulation on national banks, and to the relatively low risk tolerance of banks in general. The latter factor is particularly acute due to recent lawsuits against directors and officers of certain banks for engaging in risky or reckless lending practices.
Given this lending environment, entrepreneurs in the recreational marijuana industry have found themselves turning to investors — who demand a percentage of ownership in their business — and hard-money lenders. This article outlines some of the unique considerations for lending to the recreational marijuana industry, with a focus on Washington State.
Hard-money lenders generally encounter four types of borrowers in Washington’s recreational marijuana industry: the three types of state-licensed businesses (producers, processors and retailers) and the landlords of these businesses. When lending directly to a licensee, a lender is subject to the same requirements as the licensee — identity disclosure, criminal background restrictions, residency requirements, etc., according to Washington Administrative Code 314-55-020. That makes lending to the landlord — which would not trigger these requirements — an attractive option. Such lending may be applied toward significant improvements in the property, like grow rooms and processing facilities.
Regardless of the borrower, the availability of collateral is critical to any hard-money lender. There are four significant sources of potential collateral to secure loans. Real property is the most familiar and the most desirable to hard-money lenders, due to the ease of determining its value and the predictability of the foreclosure process upon a default. Accounts receivable and inventory are also familiar forms of collateral used routinely by commercial lenders. Each of these three forms of collateral comes with a risk of forfeiture; the federal Controlled Substances Act gives the federal government the power to seize assets traceable to, and used to facilitate, marijuana sales (see 21 U.S.C. § 88).
Inventory collateral poses an additional problem, in that liquidation of the inventory upon foreclosure would require sales of marijuana for which the lender is unlikely to be licensed.
Fortunately, Washington law envisions the use of a receiver — a court appointed third party — for purposes of foreclosure and liquidation within the recreational marijuana industry (WAC 314-55-140).
The fourth category of potential collateral is the business itself through the pledge of equity ownership to the lender. While the license held by the business generally cannot be assigned in Washington, it may be possible to seek the appointment of a receiver to liquidate not just the borrower’s inventory, but the entire business as a going concern. To our knowledge, this process has not yet been attempted and would require discussions with the Washington State Liquor Control Board before initiating the process.
Regardless of the form of collateral, it is important that lenders properly perfect their security interests. Additionally, due to unique risks described above, formulating a foreclosure plan at the inception of the loan is more critical than with other, traditional loans. An example would be to have a qualified receiver identified and agreed upon in the event default occurs. A lending agreement might also provide for other creative solutions to default that will not require foreclosure and liquidation by the lender. Beyond a loan’s inception, lenders also need to work carefully with their legal advisors throughout the life of the loan — from servicing to refinance and payoff — to ensure continuing compliance with the terms of the lending agreement.
Daniel Bugbee and Dominique Scalia are attorneys with Garvey Schubert Barer Law who specialize in bankruptcy, creditors’ rights, commercial litigation and real estate transactions.