Get Nine Protections When Leasing Property for Your Cannabis Business

Get Nine Protections When Leasing Property for Your Cannabis Business



By Glenn S. Demby, Esq.

Finally found an owner willing to lease commercial property to your legal cannabis business? Congratulations! But while securing a lease is a major accomplishment, you still have work to do. Now you have to negotiate the terms of the lease. If your owner doesn’t have a lot of experience leasing to cannabis businesses, it will probably ask you to sign the same standard form commercial lease it uses with its other tenants. Don’t do it! You’re not like the owner’s other tenants, and you can’t use the same lease they do. As a purveyor of cannabis, your business poses unique legal challenges, and you need special lease provisions to deal with them. So, you need to get your owner to revise the boilerplate lease to make it work for cannabis. Here’s how.

Context: The Contradictory & Confusing Cannabis Laws

Never for an instant forget that your owner is taking enormous legal risks by leasing to you. Cannabis laws are complex and incredibly confusing. Here’s a quick rundown of the key facts you need to appreciate when leasing commercial property for your cannabis business.

Fact 1: Cannabis is currently illegal in most states—of course, that’s changing fast.

Fact 2: Twenty-three states (and the District of Columbia) have laws allowing doctors to recommend and patients to use cannabis for specific medical conditions. In all but two of these states, licensed businesses can grow and sell the medical cannabis patients need. Presumably, you’re licensed or are seeking such a license in one of these states. Of course, you could be in one of the two states—Colorado and Washington—that have also legalized adult-use cannabis. Several other states are considering legalizing medical or adult-use cannabis. (See below for a state-by-state survey of cannabis laws.)

Fact 3: Selling and growing cannabis is illegal under federal law. Leasing to you makes your owner part of a criminal enterprise and a potential target for the local U.S. attorney, the U.S. Drug Enforcement Agency (DEA), and other federal agencies, including the IRS. It can also get the bank that holds the owner’s mortgage into trouble with federal banking regulators.

Fact 4: The federal government can enforce its anti-cannabis laws anywhere in the U.S., including within states that have adopted cannabis laws. In other words, the fact that a cannabis business is legal under the laws of your state is no defense against a federal charge. In fact, U.S. attorneys have gone after owners and tenants alike for entering into commercial leases in medical cannabis states like Montana and California.

     Question: Given these facts, why would any owner ever lease to a cannabis business? For the answer, see Fact 5.

Fact 5: Current federal policy is to live and let live and not carry out enforcement activities against cannabis businesses in states where those activities are legal under state laws, provided that the state takes effective action to keep legal cannabis out of the hands of kids and neighboring states where it’s illegal. Congress is also trying to cut off DEA funding for federal raids in cannabis states.

THE NINE LEASE PROTECTIONS YOU NEED

The current dormant state of federal enforcement makes it possible for owners in cannabis states to lease to cannabis businesses; and the fact that they can collect premium rents for taking these risks makes it profitable.

But while they have the potential to help both sides, cannabis leases can also backfire if they’re not done right. Over the decades, the commercial real estate industry has developed standard lease forms addressing the different legal issues that arise between owners and tenants. Although it provides the framework for a cannabis lease, the standard commercial lease form wasn’t created with cannabis in mind. You need to rework certain parts of the lease so it works for cannabis. Specifically, there are nine clauses that need to be revised. We’ll review them below and give you Model Lease Clauses: Make Sure Your Cannabis Lease Protects You from Legal Risks.

1. Permitted Use

Problem: Every lease has a clause that lists the activities the tenant can conduct on the premises. Normally, both sides are scrupulous about nailing down these details. But when it comes to cannabis, owners and tenants sometimes get skittish and prefer to gloss over the specifics. That’s a big problem because if the permitted use isn’t clear, you run the risk of accidentally breaking the lease by conducting an activity not permitted.  

Solution: Don’t be cute and try to cover up what you’ll be doing with the property.  Indicate that you’ll be conducting a cannabis business and list the cannabis-related activities that you’re allowed to conduct on the premises, including:

  • Prescription sale—list product form, e.g., bud, leaf, edible, drinkable;
  • Recreational sale (if you’re in Colorado or Washington)—list product form;
  • Cultivation—list maximum number of plants;
  • Processing of plant parts and resin into products; and
  • Storage for transport [Clause, Sec. 2].

2. Covenant to Comply with All Laws

Problem: Because cannabis is illegal under federal law, boilerplate clauses requiring tenants to comply with all laws and making any illegal activity a default of the lease won’t work.

Solution: The covenant needs to be modified to deal with the weird legal dynamics of cannabis:

  • You should be required to comply with all applicable state and local laws, including but not limited to the state cannabis licensing and program rules;
  • Since compliance with all federal laws is impossible, you should only have to comply with all applicable federal laws to the extent they’re not inconsistent with your right to use the premises to run a cannabis business; and
  • It’s okay to leave in the parts of the boilerplate that require you to comply with other federal laws that are not directly related to the growth, storage, and sale of cannabis—for instance, the duty to make reasonable accommodations for the disabled under the ADA [Clause, Secs. 5.1 and 5.2].

3. Owner’s Early Termination Rights

Problem: The ever-looming threat of federal intervention makes cannabis more volatile than other businesses and places an imperative on flexibility not typically found in boilerplate leases.

Solution: The lease should include an exit clause that allows for both sides to terminate the lease immediately and without further obligation to the other if specified deal-breaking legal developments take place after the lease is signed. The biggest challenge is defining the triggers.

Tenant triggers: You should be able to terminate early if new regulations, fees, taxes, or other laws are adopted that make it illegal or commercially impracticable to run your business. Expect owners to require specific, detailed notice; they might even want a “rescue” option like cutting your rent so that you can continue the lease.

Owner triggers: Your owner will probably want early termination rights in the event that leasing to you results in federal criminal prosecution, seizure of the property under federal forfeiture laws, “nuisance” prosecutions or lawsuits, foreclosure by the owner’s bank, and/or tenant rebellions. Be prepared to accept these triggers, but you may also want to make your owner fight back and not simply roll over in the face of legal proceedings. Thus, for example, the owner’s right to terminate could kick in upon not the filing of but conviction for criminal charges [Clause, Secs. 1.1 and 1.2].

4. Mode of Lease Payments

Problem: Boilerplate leases typically require tenants to pay rent by check or other financial instrument from a bank. Of course, banks are federally regulated and thus not allowed to offer loans, checking, credit cards, and other financial services to cannabis businesses. Even though the Obama administration has loosened the restrictions, many cannabis businesses are still having trouble getting access to financial services.

Solution: If you can’t get a checking account or credit card services, make sure the lease gives you the right to make payments in cash.  

5. Warranty of Suitability

Problem: Many standard leases include an owner warranty that the premises are suitable for the tenant’s proposed use. Don’t expect your owner to offer you such a warranty. Keep in mind that making premises suitable for a cannabis tenant may require significant alterations, as well as approval under building codes, zoning, state licensing, and other regulations.

Solution: List the improvements necessary to make the premises suitable for your cannabis business. Be prepared to accept sole responsibility for securing any necessary permits, licenses, and other approvals, but require the owner to take all reasonable actions to cooperate with and support your efforts, including providing information to state licensing and other regulatory authorities. If you have the leverage, you might even try to negotiate to have the owner pay part of the costs of securing the necessary approvals [Clause, Sec. 3].

6. Tenant Improvements

Like casinos, cannabis establishments must meet elaborate security requirements to get (and keep) an operating license. We’re talking exterior walls, access barriers, wall-to-wall surveillance camera systems, exterior lighting, etc. And if you intend to grow cannabis on the property, you’ll also need to install special lighting, heat lamps, and other elaborate environmental systems.

Solution: Make sure your lease specifically deals with responsibility for improvements and alterations. Key questions to negotiate:  

  • Who’s financially responsible for making the necessary improvements?
  • If you pay costs out-of-pocket, how much, if anything, will the owner reimburse you for improvements that will remain part of the premises after the lease ends?
  • Which, if any, improvements need to be dismantled at the end of the lease and at whose financial expense? [Clause, Secs. 3, and 7.1 to 7.3]

7. Owner’s Right to Inspect

Problem: Standard leases give owners the right to enter and inspect the premises to ensure that the tenant is complying with all lease requirements. But state security rules require cannabis establishments to limit access to storage, sales, and other sensitive areas. Result: You may not be allowed to let the owner enter and inspect the way it does with its other tenants.

Solution: Establish a procedure that enables the owner to inspect but that doesn’t force you to violate your duty to limit access to limited access areas. One possible solution is to require the owner to be accompanied by your own authorized employees—that is, employees or security guards who are allowed to access limited access areas. If the owner wants the right to take photos and video during inspection, make it promise to keep your trade secrets and patient records confidential as required by HIPAA and other privacy laws [Clause, Sec. 4].

8. Utilities & Other Operating Expenses

Problem: Indoor growing and storage of cannabis consumes copious amounts of water and energy. According to Forbes, an indoor module for handling four cannabis plants uses as much electricity as 29 standard refrigerators. So don’t be surprised if the owner expects you to pay for excessive consumption of water and electricity.   

Solution: Although it’s fair and reasonable to pay for any excessive utilities you consume, make sure you require the owner to:

  • Disclose the building’s overall electric and water costs;
  • Tell you what the baseline rate is for tenant consumption of water and electricity;
  • Set out a clear and fair formula for allocating excessive costs to you based on your actual consumption; and
  • Let you review utility bills to verify allocated charges [Clause, Sec. 6].

9. Common Areas

Problem: Owners typically worry that cannabis establishments will cause smoke, odors, loitering, and excessive demands on parking facilities. As a result, you may be asked to take measures to minimize risk of collateral damage to common areas, including:

  • Preventing employees and customers from consuming cannabis anywhere in the premises or common areas;  
  • Using ventilation or other mechanical devices or systems to minimize odors and keep them out of shared air circulating systems;
  • Implementing measures to prevent loitering; and
  • Appropriately disposing of waste products.

Solution: Although they may be more than the owner asks of its other tenants, these measures are typically things you need to do anyway under the cannabis program rules of your state. But if the owner asks you to do more than the state requires, such as deploy 24/7/365 security guards, you should probably negotiate for some kind of cost-sharing arrangement. 

About the Author

Glenn S. Demby is a corporate attorney and award-winning legal journalist who specializes in explaining the law in plain English and helping business leaders overcome their regulatory challenges. He can be contacted at glennsdemby@gmail.com. He thanks Professor Michael N. Widener, of Bonnett, Fairbourn, Friedman & Balint, P.C., in Phoenix, Ariz., for his help in preparing this article.

 

States Where Cannabis Businesses

Are and Aren’t Legal

Property owners can’t lease to a cannabis business unless growing and selling cannabis is legal under your state’s laws. Nearly half of the states allow this—in most states, medical is the only form of legal cannabis. Here’s a look at the current legal landscape:

Legal to grow and sell medical and recreational cannabis:

Colorado

Washington

Legal to grow and sell medical cannabis:

Arizona

California

Connecticut

Delaware

Illinois

Maine

Maryland

Massachusetts

Michigan

Minnesota

Nevada

New Hampshire

New Jersey

New Mexico

New York

Oregon

Rhode Island

Vermont

Legal to use but not sell and grow medical cannabis:

Alaska

Hawaii

Montana

Illegal to grow and sell cannabis:

Alabama

Arkansas

Florida

Georgia

Idaho

Indiana

Iowa

Kansas

Kentucky

Louisiana

Mississippi

Missouri

Nebraska

North Carolina

North Dakota

Ohio

Oklahoma

Pennsylvania

South Carolina

South Dakota

Tennessee

Texas

Utah

Virginia

West Virginia

Wisconsin

Wyoming

Notes:

  • It’s legal to sell and grow medical cannabis in Washington, D.C.
  • Florida and Pennsylvania are considering medical cannabis.
  • California, Arizona, and Oregon are considering recreational cannabis.

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