Cannabis laws give landlords a unique level of control and bargaining power over tenants. This usually leads to rents above the market and one-sided leases. Fighting with landlords is no fun, especially for cannabis tenants who can't just move to a new property and have to deal with their landlord for the duration of a license. In this post, I will explore some key concepts for cannabis tenants.
1. Get along with the landlord
This is not really a legal concept, but it is a critical one. Before you sign a multi-year contract, from which a tenant cannot essentially withdraw if he wants to stay in business, you should know who a tenant is dealing with. There is a possibility that the tenant will often have to go for landlord approval during the term of the lease. It is a good idea to understand who the landlord is before signing. If it is a challenge to negotiate basic lease terms initially, it will likely be a challenge to approve these new premises – or do something else.
2. Lessor control
It is common for rental contracts to prohibit assignment or subletting without the landlord's consent. Many leases go a step further and define a change of control by the tenant as an order that requires the landlord's approval. For example, a rental agreement may mean that the landlord must first approve a change of ownership of 25% or more of the tenant's equity.
From the lessor's point of view, these approval rights make sense; A landlord obviously wants to check incoming owners to make sure they can continue to pay rent. However, from the tenant's point of view, these provisions can sometimes lead to micromanagement by a landlord, especially if the approval threshold is low or the landlord has full discretion as to how and when to issue the permit or to make it dependent on the payment of additional money.
Many cannabis companies need investment capital, and this often means a change of ownership during the license term. If this is too broad, it can be difficult for a tenant to cope with the landlord's change of control regulations.
3. Changes to the premises
Similar to a change of control, most physical changes to the rented premises require prior approval from the landlord or at least notification. This is useful if you are thinking about changing basic parts of a building by vomiting or tearing down new walls. However, if these provisions are not well defined, they can lead to headaches. For example, would installing heavy machinery require approval? What about an HVAC system? If this is not clearly defined, disputes can arise.
Another common problem is who owns the changes to the premises. When entering into a lease, a tenant may not be able to take out everything he has put into the premises. Most leases specify who owns changes and exactly what types of changes tenants can or need to remove (in some cases). Since practically all rooms need to be changed to comply with cannabis regulations, it is important to take this into account before entering into a rental agreement.
4. Rent and compliance with legal regulations
In addition to the fixed rent, landlords can request a reduction in cannabis tenants' income. This may be feasible under state law, but raises two important concerns.
First, landlords who take part in the rent increase their risk of federal crime violations. While the federal government chose a hands-off approach to enforce state-approved operators, this could change in the future. And if enforcement priority ever changes, landlords involved in cannabis business profits could be at higher risk. This risk could also affect other provisions in the rental agreement.
Second, landlords who share in the profits are likely to need to be reported to the state and, in some cases, local authorities. In California, any form of profit sharing turns a landlord into a “financial interest holder” that must be disclosed to the state. If the profit sharing reaches certain thresholds, the landlord can be considered an “owner” and much more important information would be required. It is important to understand this second point at the beginning. Which tenant would like to be in a position where a landlord suddenly got cold feet after signing a lease and applying for a license and refused to comply with the government disclosure requirements? This would probably not end well for anyone.
Cannabis landlords often require that leases be “guaranteed” by third parties. A guarantee is essentially an agreement by a third party to pay the rent and other financial obligations of the tenant if the tenant falls behind with the rental agreement. If the landlord requests a personal guarantee from the owner of a cannabis company, this can be important as this can lead to serious personal liability on the part of the guarantor if the tenant of a cannabis tenant is unable to make his payments. This risk is even more pronounced for cannabis companies. Cannabis companies take a considerable amount of time (without income) to be operational, and the loss of licenses also results in lost income.
6. Due diligence
Most leases contain assurances and guarantees for the property to be rented. However, it goes without saying that verifying the accuracy of the representations (through inspections and otherwise) is crucial. If a tenant signs a rental agreement without inspecting the property, he can waive his right to make claims later (this does not apply if the landlord intentionally misrepresented something).
Because cannabis permits and licenses are tied to certain properties, it is important for most tenants to tie the landlord to the lease as much as possible. Wide termination rights can be bad for tenants for obvious reasons. It is always a good idea to carefully examine the reasons for termination. Two things crop up frequently that need to be considered.
First is the ability of a landlord to cancel due to a violation (this usually happens when the rent is not paid). With some rental contracts, the tenant can allow a period to remedy violations. However, we have seen a lot of time with very short fix times that may not always be adhered to.
Second is the termination for violation of the law. By default, cannabis rental contracts violate federal law. If a rental agreement can be terminated due to a violation of a law, it can possibly be terminated from the first day. Of course, there are good arguments that a landlord has waived his right of termination or has not given good faith notice if that is the justification for the termination. but why come into this position at all?
8. Dispute settlement
That is absolutely critical. As a lawyer who previously handled only business disputes and saw firsthand the effects of poorly worded dispute settlement provisions, I cannot express enough how important it is to focus on these clauses. This applies in particular to cannabis contracts and in particular to cannabis leasing contracts.
Every time a cannabis dispute ends up before a federal court, there is a possibility that the court will refuse to maintain a contract on the grounds that it violates federal law (this is known as federal unlawful defense, and it has even been believed that he was beaten over the federal court, it is still very much alive). This risk is immense for cannabis tenants. If a court refuses to maintain a lease, or worse, it is void, the tenant may lose his licensed premises and thereby his license.
These are just a few questions that potential cannabis tenants should ask themselves when considering a lease. The actual factors are likely to change significantly from lease to lease and from jurisdiction to jurisdiction. It's a good idea to work with a lawyer to find out which lease terms are best for a particular tenant and jurisdiction.
The big advantage here should be that drafting and negotiating cannabis rental contracts is difficult and that cannabis rental companies, if not controlled, can exercise great power over tenants. Please visit the law Law Blog for further developments in cannabis leasing law and in the meantime read the articles linked below.