LEX CANNA

Proposed Emergency Regulations Raise a Range of Concerns

On November 16, 2017, the Bureau of Cannabis Control (“BCC”) released its proposed emergency cannabis regulations. The emergency rulemaking procedure is expedited and allowed only a five-day window for the public to submit comments.

The next step in the rulemaking process occurred on November 28, when the BCC submitted the proposed rules to the Office of Administrative Law for review and potential adoption. This triggered another five-day comment period.

With such a rushed process and limited opportunity for public discourse, there is an obvious risk of regulations riddled with ambiguities, unintended meanings, and outright errors. Over time, of course, the BCC promulgate final regulations, and will continue to refine them, but initially the industry will face some frustrating results of a hurried regulatory process.

This post describes just some of the potential problems with the proposed emergency regulations. It covers only the BCC regulations (at Cal. Code of Regs., Title 16, Div. 42, “Bureau of Cannabis Control”). The same emergency rulemaking procedure, fraught with the same risks, is under way for the Department of Health regulations for cannabis manufacturing (at Cal. Code of Regs., Title 17, Div. 1, Ch. 13, “Manufactured Cannabis Safety) and the Department of Food and Agriculture regulations for cultivation (at Cal. Code of Regs., Title 3, Div. 8, “Cannabis Cultivation”).

For each proposed regulation discussed below, we suggest potential corrections and modifications. Comments along these lines have been submitted to the BCC and Office of Administrative Law.

  • 5003 Designation of Owner

(Presented first, rather than in order, because of its importance and potential impact.)

This section describes which individuals and entities will be considered the “owners,” and therefore “applicants,” connected to each application for a state cannabis license. It states in part (emphasized language is suggested modification):

(b)(4): “An individual who will be participating in the direction, control, or management of the person applying for a license. An owner who is an individual participating in the direction, control, or management of the commercial cannabis business includes any of the following:

  • A partner of a commercial cannabis business that is organized as a partnership.
  • A member of a member-managed limited liability company of a commercial cannabis business that is organized as a limited liability company.
  • An officer or director of a commercial cannabis business that is organized as a corporation.

This comment concerns only the language in (b)(4)(B), which would deem every member of an LLC to be “participating in the direction, control, or management of the person applying for a license” and therefore an “owner” for licensing purposes.

While this categorical approach has the benefit of simplicity, it results in an unreasonable definition of “direction, control, or management.” Just like purchasing shares in a corporation does not necessarily give a shareholder control over any of its operations, membership in an LLC does not necessarily impart any authority to direct, control, or manage the company, especially when the LLC is not member-managed. When an LLC is not member-managed, merely owning membership interests gives a member no authority to manage the company whatsoever.

The draft language will cause major—and unnecessary—confusion in the industry. Many cannabis businesses are structured as LLCs. Minority investors who assume no active role in such LLCs will be shocked to learn that the Bureau will consider them “owners” and “applicants” for state licenses simply because they purchased membership interests in the company. This will likely result in companies scrambling to restructure themselves as corporations, so that minority shareholders can remain “non-owners” by remaining below the 20 percent ownership threshold. This is an arbitrary, expensive, and unnecessary obstacle for companies as they work hard to address all of the requirements to enter California’s new regulated cannabis marketplace.

Moreover, this is a drastic departure from the language included in the regulations under the now-repealed MCRSA. Section 5004(b)(3) of those regulations was the analog to the current section at issue here. It set forth basic guidelines for determining what constitutes actual participation in “direction, control, or management.”

As indicated above, the regulation should be limited appropriately (so that subsection (b)(4)(B) applies only to member-managed LLCs). Alternatively, it should revert to the approach used by the now-withdrawn regulations, which included the following language to define when an individual’s control over a business means the individual should be considered an “owner”:

“For purposes of this section, participating in the direction, control, or management of the licensed commercial cannabis business means that the individual has been delegated discretionary powers to organize, direct, carry on or control the operations of the licensed commercial cannabis business. Authority to control one or more of the following functions may be considered evidence that such an individual is participating in the direction, control, or management of the licensed commercial cannabis business:

  • To hire or separate employees.
  • To contract for the purchase or sale of medical cannabis goods.

(C) To make or participate in making policy decisions relative to operations of the licensed commercial cannabis business.”

  • 5001. Temporary License Application Requirements

This section describes the temporary licenses that the BCC will begin issuing in 2018 pursuant to Bus. & Prof. Code section 26050.1. That section, however, only authorizes temporary licenses to be issued through January 1, 2019, and the regulation fails to mention that timeframe. This needs to be clarified.

  • 5014. Fees

 This regulation concerns the license fees. It states in part (emphasized language is suggested modification):

(c) In determining the appropriate license fee to be charged, each applicant or licensee shall estimate the maximum dollar value of its planned operation in terms of the value of the product based on average market price . . . as determined in assessing the 15% excise tax pursuant to Revenue and Taxation Code section 34011.

The regulation refers to “value of the product” and section 34011 of the Revenue and Taxation Code.Section 34011, however, refers to (and defines) “average market price,” not “value of the product.” It is unclear whether these terms are meant to be the same. If they are, consistent terminology should be used, as suggested.

  • 5024. Death or Incapacity of a Licensee

This section concerns what happens when a licensee becomes incapacitated, either by death or for any other legal reason. It explains the rights of the “successor in interest,” which may be granted “approval to continue operations on the licensed business premises for a period of time.”

We have recommended that a provision similar to this be included to address a landlord’s rights after its tenant-licensee either abandons the property or is lawfully evicted. Under such circumstances, landlords may be left with a crop of cannabis but no legal way to arrange for it to be put to beneficial use.

This is especially a problem for landlords who wish to mitigate their loss after making significant improvements to their property to accommodate tenants, only to have those tenants breach their lease early in its term. In such a scenario, eviction before a harvest would likely harm the landlord’s potential recovery against the tenant. Without a regulation that treats landlords in a way similar to how this draft regulation treats a “successor in interest,” landlords may face extreme financial pressure not to evict defaulting tenants when the tenant is the only party able to bring the cannabis grown on the property to market. Given the potential for cannabis cultivation to cause environmental harm and other nuisances, this presents a significant public policy concern. Regulations should remove incentives for landlords to allow bad actors to remain on their property.

  • 5303. Packaging and Labeling

 This regulation concerns cannabinoids testing. It states in part (emphasized language is suggested modification):

“(c) Notwithstanding subsection (b) of this section, if it is determined during laboratory testing that a manufactured product is labeled with the incorrect amount of THC any cannabinoid per package or serving but is within the THC limits for sale for such cannabinoid, the distributor may re-label the package with the accurate THC cannabinoid amount”

This provision concerns correcting mislabeled products with respect to THC content per package only. It is unclear why THC is singled out among the cannabinoids for label correction by the distributor. This provision should allow for correction with respect to any of the cannabinoids tested.

  • 5304. Testing Arrangements

 This regulation concerns the coordination between distributors and testing labs. It states in part:

“After taking physical possession of a cannabis goods batch, the distributor shall contact a testing laboratory and arrange for a laboratory employee to come to the distributor’s licensed premises to select a representative sample for laboratory testing.”

This is ambiguous because it is not clear whether “to select a representative sample” means the lab employee physically takes the sample and brings it to the laboratory for testing. In other words, does the laboratory licensee take the sample to the lab for testing, or does the distributor transport it? This should be made clear.

  • 5311. Requirements for the Transportation of Cannabis Goods

This regulation concerns the flexibility that a distributor has regarding its travel between locations while transporting cannabis. It states in part (emphasized language is suggested modification):

“(j) A distributor transporting cannabis goods shall only travel between a licensees shipping or receiving cannabis goods and its own licensed premises when engaged in the transportation of cannabis goods, or between a licensee shipping or receiving cannabis and another licensee shipping or receiving cannabis. The distributor may transport multiple shipments of cannabis goods at once in accordance with applicable laws.”

It is unclear whether this regulation allows a distributor to make multiple stops when transporting cannabis goods. As written, the first sentence literally requires a distributor to only travel between its own premises and a licensee’s premises. But the second sentence confusingly states that “multiple shipments” can be transported at once. The regulation should clearly permit distributors to travel between licensees.

  • 5405. Cannabis Goods Display

 This regulation addresses the removal of cannabis from packaging for customer inspection by retail licensees. It states in part (emphasized language is suggested modification):

  “(c) Cannabis goods may be removed from their packaging and placed in containers to allow for customer inspection. The consumer may purchase such cannabis goods removed from packaging for inspection. The containers shall not be readily accessible to customers without assistance of retailer personnel. A container must be provided to the customer by the retailer or its employees, who shall remain with the customer at all times that the container is being inspected by the customer.”

The proposed text does not make clear whether the cannabis removed from packaging to allow for customer inspection may be sold, as opposed to requiring the customer to purchase still-unopened cannabis goods.

  • 5420. Delivery Request Receipt

This section lays out the process for delivering cannabis, including the requirement that a “delivery request receipt” be created. The proposed text does not make clear whether such a receipt needs to be in hard copy, as opposed to electronic. Receipts can be signed using mobile devices, provided to customers via email, and retained by the retailer electronically, for example. The regulation should make clear whether it allows for the use of such technology.

  • 5504. Microbusiness Applications Including Manufacturing Activities

This section concerns the information that must be provided to the Bureau for microbusiness license applications. It states, among other requirements, that an applicant must provide specific information about its products, including “(3) Amount of cannabidiol (CBD) or tetrahydrocannabinol (THC) in the product.”

Requiring a specific measurement like this during the licensing phase, before any product has been manufactured and tested, is unduly burdensome.

Moreover, this requirement is confusing because it calls for the amount of CBD or THC in the product. If a product is planned to contain both CBD and THC, this proposed regulation confusingly only requires the applicant to state the amount of one or the other. This is most likely a drafting error and should be corrected.

  • 5602. Temporary Cannabis Event Sales

 This section concerns cannabis sales at “temporary cannabis events.” It states in part:

“(k) The daily sales limits under section 5409 of this division apply to sales made at a cannabis event.”

Section 5409 sets forth the maximum amount of cannabis that a retailer can sell to a single customer (e.g., for adult-use, 28.5 grams of flower per day; 8 grams of concentrate per day). Without more explanation, how to apply section 5409 to an entire event is unclear. For example, does the daily sales limit under section 5409 apply to each licensee present at the event separately, or to the event as a whole? This should be clarified.

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