By all accounts, the biggest news in cannabis over the past month has been the legalization of adult-use cannabis in New York, making it the 16th state to legalize cannabis.
The Marijuana Regulation and Taxation Act, sponsored by Senator Crystal Peoples-Stokes and Assembly Majority Leader Liz Krueger, sailed through the State Assembly (100-49) and Senate (40-23) and was signed by Governor Andrew Cuomo mere hours after hitting his desk. The MRTA is one of the most progressive, if not the most progressive, pieces of cannabis legislation in terms of social justice measures. Possession of up to 3 ounces of cannabis and 24 grams of cannabis concentrate is immediately legal; expungement of previous marijuana convictions that are now legal is automatic; 40% of the estimated $350 million in annual tax revenue will be allocated to reinvestment into communities disproportionately impacted by the failed War on Drugs (9% at the state level and 4% at the local level, not including a tax of 3 cents per milligram of THC imposed upon distributors); and 50% of the adult-use licenses will be reserved for social equity applicants.
However, among the most prominent features of the MRTA are its prohibition on vertical integration and caps on the number of licenses an individual or entity may own. These measures were reportedly taken to support small businesses and social equity applicants. But they will also prevent businesses from scaling operations, which could make it difficult for such businesses to attract investors.
Specifically, individuals may not have a direct or indirect financial or controlling interest in more than four adult-use retail licenses. Plus, retail licensees are prohibited from holding adult-use cultivation, processor, microbusiness, cooperative or distributor licenses (unless they are a medical cannabis operator, with special permission from the state to operate in the adult-use market).
Adult-use distributors will be prohibited from having a direct or indirect economic interest in any microbusiness, adult-use retail store, adult-use on-site consumption license or any medical cannabis business, but they will be permitted to maintain an interest in a cultivator or processor license, provided that they only distribute cannabis or cannabis products grown and/or processed by that licensee.
Adult-use processors will be able to obtain a distributor’s license, but only for the distribution of their own products. They will be permitted to hold only one processor license each. And they are prohibited from having a direct or indirect interest — including by stock ownership, interlocking directors, mortgage or lien, personal or real property, management agreement, sharing of parent companies or affiliated organization or any other means — in any business licensed as an adult-use cannabis retailer or registered medical cannabis organization, including any premises thereof.
Adult-use cultivators may also hold one processor and one distributor license (solely for the distribution of their own products), but as with processors, are limited to one license each and are banned from having a direct/indirect interest in retail establishments or registered medical cannabis organizations.
These prohibitions are restrictive but not unprecedented. For instance, Washington state has always banned vertical integration among producers and retailers. In Massachusetts, dispensaries are subject to a maximum of three stores each. And for the first two years of the adult-use program in New Jersey, the state will impose caps on the number of licenses an individual/entity may hold and prohibit “coupling” of certain license types, such as between cultivation/manufacturing and wholesale/retail.
For investors and operators, these prohibitions must be addressed in organizational documents. Most cannabis businesses already include “loss of license” provisions in their organizational documents, which empower companies to repurchase the ownership interest of a shareholder who puts the company’s cannabis license at stake. In those instances, companies typically exercise an immediate repurchase right, at some sort of punitive value (such as book value, as opposed to fair market value), coupled with the imposition of costs and fees for attorneys and state fines.
When faced with a shareholder who, by virtue of their existing investments or other deals in queue, finds themself in violation of a license cap or other prohibition, it may not be appropriate to subject their entire interest to a punitive redemption measure, as with a loss of license provision. Instead, in their organizational documents, operators should include redemption and divestment clauses, designed to claw back only the number of shares necessary to enable the shareholder to maintain as much of their original stake as possible without triggering a regulatory violation. Depending upon which party has more leverage (the company or the shareholder), the repurchase price could be the original purchase price, the fair market value (which may or may not need to be determined by an independent third-party appraiser) or the greater of the two. Care should be taken to carefully describe and acknowledge regulatory restrictions and requirements, and to obtain representations from shareholders regarding the existence of known regulatory “problems.”
Navigating the new cannabis market in New York, the 13th largest economy in the world, will inevitably require careful planning and a robust understanding of applicable laws, but the opportunity and prospective reward should be worth the trouble.