In 2020, state courts still seem to be a good bet for cannabis businesses in cannabis-legal states. But federal courts are sliding backward.
A few weeks back, the Cannabis Law Institute invited me to discuss contract drafting for cannabis deals. A focal point for the panel was whether courts are willing to enforce cannabis contracts. The last time I had really looked at that issue was early 2019, when I wrote: Cannabis Dispute? Courts are Open. As the title indicates, my research (and our law firm’s experience) showed that both state and federal courts were generally open to resolving cannabis contract disputes at the time. And I assumed the trend had held. Unfortunately, it has not!
In the 2019 piece, I summarized:
[Contract enforceability] was always the biggest consideration in choosing a forum for cannabis disputes. A few months ago, we ran a survey of federal courts and cannabis litigation, observing that none of the districts at issue were invalidating state-sanctioned businesses’ cannabis contracts on the dreaded “illegal purpose” basis. This trend is holding strong in recent federal court disputes on issues from RICO to patent infringement, despite the prohibited status of “marijuana” under federal law. As to state courts, the decisions declining to hear cannabis beefs are pretty far in the rearview. (Ironically, it has been safer overall to enforce cannabis contracts in federal courts that state courts to date.) When drafting agreements for cannabis clients, we still advise as to the diminishing possibility of non-enforcement, but most cannabis companies seem comfortable choosing court over arbitration if other goals are satisfied.
In 2020, state courts still seem to be a good bet for cannabis businesses in cannabis-legal states. Although I have not run a formal survey, I also have not come across local courts tossing disputes solely because the contract related to cannabis activities (and our cannabis business litigators have worked on many of these cases). But federal courts are sliding backward. A trio of cases in Washington, Oregon and Nevada show why.
Before running that dismal gauntlet, it’s important to understand the rationale used by federal courts to enforce cannabis contracts previously. The touchstone ruling here is found in Mann v. Gullickson, 2016 WL 6473215 (N.D. Cal. Nov. 2, 2016). In that case, the court observed that “[n]o principle of law is better settled than that a party to an illegal contract cannot come into a court of law and ask to have his illegal objects carried out…” (quoting Wong v. Tenneco, Inc., 39 Cal. 3d 126, 135 (1985)). That makes sense, right? For example, if Party A pays Party B to start a forest fire, but Party B pockets the cash and skips town, no court would require Party B to return and start the fires. The contract would be void for public policy reasons.
But there’s some wiggle room here. The Mann court also observed that “[e]ven where contracts concern illegal objects, where it is possible for a court to enforce a contract in a way that does not require illegal conduct, the court is not barred from according such relief.” As such, the court determined it could require a cannabis company borrower to repay a loan it had received (provided the case did not settle between summary judgment and trial). Requiring someone to repay a loan, after all, doesn’t require the debtor to violate any laws– even if the debtor is a scofflaw.
In legal terms, what the Mann court did is “sever” the narrow, kosher contract requirements from the broader, “illegal contract” at issue. This is in keeping with our early 2019 survey of the federal courts, mentioned above. Specifically, we concluded in that blog post that courts were “find[ing] ways around invalidating contracts simply because they happen to involve cannabis–and sometimes even when they include terms that require parties to violate federal law–so long as those provisions are severable.”
Unfortunately, courts seem to be rethinking this approach, not just in jurisdictions that comprise states without legal cannabis programs, but in states that have taken the lead on ending prohibition. Below are the 2020 decisions in Washington, Oregon and Nevada, which show courts backing up a bit. Bart St. III v. ACC Enterprises, LLC, No. 217CV00083GMNVCF, 2020 WL 1638329 (D. Nev. Apr. 1, 2020) Like Mann, Bart St. is a loan default case. Plaintiff lent defendant, a cannabis grower, $4.7 million under a contract governed by Nevada law. When the defendant defaulted, plaintiff sued for breach of contract and unjust enrichment. Defendant argued that it couldn’t be liable for breach of contract: under federal law, the contract was illegal. The judge agreed as to various portions of the contract, but could not decide on summary judgment whether the illegal provisions could be severed from the rest of the agreement. For that reason, the defendant’s summary judgment motion was denied on the breach of contract claim. As to the unjust enrichment claim, the judge wrote:
Plaintiff cannot prevail for unjust enrichment because the parties’ contract involves moral turpitude. If the Contract is unenforceable, it is because Plaintiff invested in Defendants’ marijuana cultivation business primarily to obtain a pathway to an equity investment therein . . . . Providing funds in exchange for equity violates the CSA because it would allow the investor to profit from the cultivation, possession, and sale of marijuana . . . . Conspiracy to cultivate marijuana is a crime of moral turpitude.