Cannabis Archives - Gupta Evans and Ayres

The Sphinx on Skunk: Justice Thomas Speaks Out(!) on the Inconsistent Enforcement of Federal Cannabis Prohibition

July 21, 2021/in All Blog Posts, Cannabis, Corporate Litigation/by Jake Ayres

They say that war makes for strange bedfellows. As it turns out, the war on drugs is no exception. In a recent opinion from the United States Supreme Court, conservative stalwart Justice Clarence Thomas rebuked the federal government’s “half-in, half-out” stance on state-legal cannabis, and strongly implied that said approach was untenable from a federalist perspective. This criticism of federal drug policy from the right—rather than the left—could be another omen that more cultural conservative objections to state-legal cannabis are yielding to federalism and economic concerns and could also signal a future bipartisan action to provide safer harbor to legal cannabis businesses.

In Standing Akimbo, LLC v. United States, 594 U.S. __ (2021), the Supreme Court, on June 28, 2021, denied certiorari to a medical cannabis dispensary in Colorado attempting to prevent disclosure of certain company records sought by the IRS. The dispensary was accused by the IRS of impermissibly using 280E of the Internal Revenue Code to deduct business expenses; as the law stands now, cannabis businesses, because they deal in a federally illegal substance, can only deduct the costs of goods sold.

However, in so doing, Justice Thomas took the opportunity to wag his finger at the inconsistency of federal enforcement of the illegality of cannabis: “[T]he Federal Government’s current approach to marijuana bears little resemblance to the watertight nationwide prohibition that closely divided Court found necessary to justify the Government’s blanket prohibition in Raich.” Id. A known advocate for federalist principles, he went on to note that “[i]f the Government is now content to allow States to act ‘as laboratories’ ‘and try novel social and economic experiments,’. . . then it might no longer have authority to intrude on ‘the States’ core policy powers . . . to define criminal law and to protect the health, safety, and welfare of their citizens.’” Id. (quoting Gonzales v. Raich, 545 U.S. 1, 42 (2005) (O’Connor, J., dissenting)).

Justice Thomas’s references to Raich (and Justice O’Connor’s dissent therein) is unsurprising given his own dissenting opinion in that case, in which he voiced similar concerns of federal commerce clause power overreach. Raich, 545 U.S. at 57 (Thomas, J., dissenting). In Raich, the majority held that the federal government had power under the commerce clause to regulate state-legal intrastate cannabis—that is, cannabis that is grown, distributed, and consumed within a state where it is legal. Id. at 22.

Justice Thomas opined that intrastate regulation in that context went beyond the federal government’s commerce clause powers, in that cultivation and consumption of medical cannabis entirely in California was not “commerce” nor interstate. Id. at 59. Moreover, although the majority substantially relied on Wickard v. Filburn, 317 U.S. 111 (1942) for the proposition that intrastate commerce that has a “substantial effect” on interstate commerce is within Congress’ regulatory power, Justice Thomas agreed with Justice O’Connor’s criticism of the majority’s reliance on Wickard. In Justice O’Connor’s dissent, she noted that, unlike Wickard, where the Court was presented with economic studies documenting the effects of personal intrastate wheat cultivation on the interstate wheat industry at large, there was no actual evidence that the small-scale medical cultivation and consumption by appellants had any “substantial effects” on interstate commerce. Id. at 53-54 (O’Connor, J., dissenting); id. at 67 (Thomas, J., dissenting). For his own part, Thomas criticized the majority’s apparent use of the Necessary and Proper Clause to hold that exercising federal police powers over intrastate legal cannabis cultivation was “necessary” to avoid a “gaping hole” in the Controlled Substances Act, id. at 21, reasoning that there was no evidence before the Court to suggest that failing to regulate intrastate cannabis cultivation and use would result in an inability to control interstate drug trafficking, id. at 63 (Thomas, J., dissenting), a criticism he alluded to in Standing Akimbo. 594 U.S. at __ (“A prohibition on intrastate use or cultivation of marijuana may no longer be necessary or proper to support the Federal Government’s piecemeal approach.”).

Indeed, these statements—from an eminent conservative, no less—could be a wake-up call for activist litigation to challenge the ruling in Raich, or for Congress to act to provide some measure of legalization or safe harbor to state-legal cannabis operators. As I have written previously, even if an impact litigant were to challenge Raich on its own rationale—without delving into the more academic discourse of Thomas’s dissent—such a challenge might bear fruit.

In reaching its final holding that Congress had a rational basis for concluding that intrastate cannabis cultivation would have a “substantial effect” on its ability to regulate interstate cannabis commerce, the Court in Raich explicitly premised its decision upon (1) difficulties distinguishing between state-legal cannabis and illegal cannabis grown elsewhere and (2) “concerns about diversion [of state-legal cannabis] into illicit channels.” 545 U.S. at 22. As more and more states legalize cannabis in some fashion—36 states have legalized adult-use cannabis, medical cannabis, or both—both of points one and two become weaker and weaker. That is, as to point one, as legal cannabis packaging becomes more regulated and sophisticated, the visible difference between legal cannabis and illegal cannabis becomes more and more obvious. As to point two, as more and more states legalize, it becomes less and less likely for legal cannabis to be “diverted” into illicit channels. For example, nearly the entire Pacific bloc of states—California, Oregon, Washington, Nevada, Arizona, and Colorado—have legalized medical and adult-use cannabis. Leaving aside state law prohibitions, legal cannabis moved throughout this region is very unlikely to result in “diversion” of legal cannabis “into illicit channels.”

Although whether this shot across the bow of the federal government’s cannabis enforcement regime will result in or motivate any lasting change—either judicially or legislatively—remains to be seen, the cannabis industry will likely view this statement of support from a somewhat unexpected source as a moral victory.

Chapter 420, Part II: Closing the Book on Cannabis-Adjacent Bankruptcy

July 7, 2021/in All Blog Posts, Bankruptcy, Cannabis, Corporate Litigation/by Jake Ayres

In a previous article, I discussed the potential impacts of a then-forthcoming decision in the case of In re United Cannabis Corporation, which had the potential to widen access to federal bankruptcy relief to cannabis-adjacent hemp businesses.

However, the In re United Cannabis case ended not with a bang, but with a whimper. On January 12, 2021, after approximately eight months of consideration, Bankruptcy Judge Joseph G. Rosania, Jr. of the District of Colorado issued a one-page ruling dismissing[1] the bankruptcy petition “pursuant to 11 U.S.C. § 1112(b) and . . . finding good cause.” In so doing, he snuffed out any hope that the District of Colorado could become a hub for hemp businesses that dabble in cannabis to successfully pursue chapter 11 bankruptcy.

Because the ruling does not provide any substantive reasoning for the decision, industry observers are left to speculate. One can only assume that the court found the evidence offered by the U.S. Trustee—namely, that the debtor was not nearly as removed from the cannabis arena as it purported to be based on the debtor’s website and marketing materials—credible enough to justify dismissal on the grounds that a plan of reorganization could not be untainted by federally illegal cannabis money. In so doing, the court left the fundamental question of how the 2018 Farm Bill’s legalization of hemp affects the availability of bankruptcy to businesses that have toes in both the cannabis and hemp pools. For the time being, the safer route—and the route perhaps favored by conventional wisdom—for businesses is to completely segregate their cannabis and hemp businesses, both on a practical and corporate/legal level.

The Bankruptcy Court for the District of Colorado’s declination to decide the issue raised by Way to Grow only illuminates other quirks in the current state of affairs for bankruptcy in the cannabis context. In particular, the ruling in United Cannabis displays the tension between how different bankruptcy courts have construed section 1112 vis-à-vis section 1129(a)(3).

Section 1129(a)(3) provides that a bankruptcy plan shall only be confirmed where, inter alia, “[t]he plan has been proposed in good faith and not by any means forbidden by law.” On its face, this statute would seem to preclude plans funded by federally illegal cannabis, given that those funds would be derived from a “means forbidden by law.” However, the Ninth Circuit disagreed in Garvin v. Cook Investments NW, SPNWY, LLC, 922 F.3d 1031 (9th Cir. 2019). In that case, the Ninth Circuit affirmed the Bankruptcy Court for the Western District of Washington’s confirmation of a chapter 11 plan for reorganization over the U.S. Trustee’s objection that one of the debtors was renting real property to a cannabis growing operation. Id. The Ninth Circuit parsed the language of section 1129(a)(3) quite narrowly, holding that that subsection “directs bankruptcy courts to policy the means of a reorganization plan’s proposal, not its substantive provisions.” Id.at 1033. The Ninth Circuit applied that interpretation to the case at bar, and found that although income funneled into the plan would ultimately be derived from a federally illegal source—the cannabis grower tenant—that had no bearing on whether the plan had been proposed in good faith. See id. at 1035-36. Importantly, the Ninth Circuit refused to rule on the argument that section 1112(b) mandated dismissal of the petition, concluding that “the Trustee waived the argument by failing to renew its motion to dismiss” after the Bankruptcy Court’s initial dismissal of a previous motion to dismiss with leave to renew at the plan confirmation hearing. Id. at 1033-34.

This literal interpretation of section 1129(a)(3) has been explicitly criticized in courts within other circuits. Indeed, the Bankruptcy Court for the Eastern District of Michigan sharply critiqued Garvin in dicta for its de facto affirmation of illegal conduct pursuant to a bankruptcy plan:

This Court does not necessarily agree with the Garvin court’s holding about § 1112(a)(3). And, respectfully, one might reasonably question whether the Garvin court should have refused to decide the § 1112(b) dismissal issue. That refusal, on waiver grounds, arguably is questionable, because it allowed the affirmance, by a federal court, of the confirmation of a Chapter 11 plan under which a debtor would continue to violate federal criminal law under the [Controlled Substances Act].

In re Basrah Custom Design, Inc., 600 B.R. 368, 381 n.38 (Bankr. E.D. Mich. 2019).

Moreover, the District Court of Colorado in In re Way to Grow, the very case that seemingly left the door open for United Cannabis in the first place, also criticized Garvin for unduly focusing on the “means forbidden by law” clause of section 1129(a)(3), rather than the “good faith” portion of the same. 610 B.R. 338.

As a result, there is an embryonic circuit split on the issue of interpreting section 1129(a)(3) as applied to cannabis business petitioners, with the Ninth Circuit in the minority and the Sixth and Tenth Circuits in the presumptive majority.

As fascinating as this may be on an academic level, for businesses in the cannabis industry, this circuit split will likely have little bearing on the ultimate issue of whether businesses that dabble in cannabis can obtain the benefits of federal bankruptcy. Reason being, section 1129(a)(3) is just one ground for dismissal on the basis of illegality. Garvin itself noted in its final paragraphs that there are plenty of other reasons to dismiss cannabis bankruptcies—not the least of which is section 1112(b). Garvin, 922 F.3d at 1036. Indeed, running an illegal business as part of a bankruptcy plan could conceivably run afoul of any number of the listed bases for “cause” under section 1112(b)(4), including but not limited to the “gross mismanagement of the estate” prong name checked by the court in Garvin.

The unceremonious dismissal of the petition in United Cannabis raises more questions than answers. Unless and until cannabis is descheduled, or some other form of federal reform occurs, the Bankruptcy Courts will be left to continue to battle it out over interpretations of section 1129(a)(3), comfortable in the knowledge that section 1112 provides a backstop for dismissing cannabis-funded petitions and plans. However, the issue raised in United Cannabis—whether a company that has cannabis-derived revenue can have a chapter 11 plan approved if the plan doesn’t require that revenue—remains tantalizingly unanswered for now.

[1] Curiously, the court styled the order as one “granting” the U.S. Trustee’s “Motion to Dismiss Chapter 11 Cases pursuant to 11 U.S.C. § 1112(b).” However, the U.S. Trustee never filed a Motion to Dismiss. Rather, the U.S. Trustee filed a response to the court’s own Order to Show Cause why the petition should not be dismissed—although, that response did raise section 1112(b) as a reason for dismissing the case.

MORE Legislation, MORE Problems: The MORE Act to Legalize Cannabis Passes the House

December 17, 2020/in All Blog Posts, Cannabis, Corporate Litigation/by Jake Ayres

On December 4, 2020,¹ the United States House of Representatives made history and voted to federally legalize cannabis for the first time by voting to pass the Marijuana Opportunity Reinvestment and Expungement Act (the “MORE Act”). Although the MORE Act still has to pass the historically cannabis-unfriendly United States Senate, the House’s quick action to pass a sweeping legalization bill in a time of presidential transition could signal greater legislative efforts to resolve the federal-state tension over state-legal cannabis.

The key provision of the MORE Act would be to federally deschedule cannabis and thereby remove it from the purview of the Controlled Substances Act. The MORE Act also would enact a 5% federal tax—which would step up by a point each year after the first two years after enactment up to 8%—on cannabis products and earmark those tax revenues to fund various social justice measures via a trust fund (the “Opportunity Trust Fund”). The Opportunity Trust Fund’s money would help fund the Community Reinvestment Grant Program (the “CRGP”), also established by the statute. The CRGP, administered by the newly created Cannabis Justice Office, would be responsible for “provid[ing] eligible entities with funds to administer services for individuals adversely impacted by the War on Drugs, including (1) job training; (2) reentry services; (3) legal aid for civil and criminal cases, including expungement of cannabis convictions; (4) literacy programs; (5) youth recreation or mentoring programs; and (6) health education programs.”

The MORE Act also has several other social justice measures embedded within it. First, it prohibits the denial of any “Federal public benefit”—e.g., welfare benefits, etc.—on the basis of any cannabis-related conduct. Second, the MORE Act would also explicitly authorize SBA loans to legal cannabis businesses. Third, and perhaps most potently, the MORE Act would provide for an automatic expungement process for nonviolent cannabis convictions, where each Federal district would initiate the process without any affirmative steps by the convicted person.

Importantly, despite the proposed sweeping federal changes, the MORE Act would preserve the current federalist contours—that is, individual states can still decide on whether to legalize or prohibit cannabis.

Although the House’s passage of the MORE Act is a watershed moment for cannabis in the United States, it is difficult for the industry to maintain too much excitement given the current United State Senate’s propensity for killing bills, or at least allowing them to die in that chamber. Even putting aside the sweeping legalization measures, the social justice strands of the MORE Act may be the dealbreakers for Congressional republicans, some of whom have already said as much publicly. Of course, if both Georgia Senate seats flip to democrats in the January runoff elections, the 50/50 split in the Senate, then the bill is teed up to have Vice President (and MORE Act Senate sponsor) Harris pushing the bill over the hump.

If that Senate scenario does not come to pass, the likely outcome seems to be that the extremity of the MORE Act may make more incremental cannabis legalization—like the STATES Act, which would federally deschedule cannabis without any other attendant social justice measures—more appealing to a recalcitrant Senate. Even more likely may be the SAFE Banking Act, which would not federally deschedule cannabis, but would provide safe harbor to the financial industry (among other service providers) who service the cannabis industry. Of course, if the MORE Act were to be enacted, it would presumably eliminate the financial industry’s objections to banking for and lending to state-legal cannabis businesses.

In the meantime, cannabis industry participants and onlookers will eagerly watch how this bill fares as the canary in the Senatorial coal mine.

¹ Appropriately enough, the date of the House’s vote was Jay Z’s birthday. However, Jay himself did not identify as a heavy cannabis user, preferring to consume “once in a blue when there’s nothing to do/And the tension gets too thick for [his] sober mind to cut through.” That being said, Jay is ostensibly pro-legalization, having recently introduced his own brand of cannabis and cannabis accessories. Chris Gardner, Jay-Z Debuts Product Line for Cannabis Brand Monogram, The Hollywood Reporter (Dec. 10, 2020), available at https://www.hollywoodreporter.com/rambling-reporter/jay-z-debuts-product-line-for-cannabis-brand-monogram

Chapter 420 Bankruptcy?: How In re United Cannabis Could Open the Doors to Bankruptcy Relief for Cannabis-Adjacent Businesses

September 12, 2020/in All Blog Posts, Cannabis, Corporate Litigation/by Jake Ayres

Let’s say you’re a hemp/CBD business (that also services the cannabis industry in a limited capacity) and COVID-19 has hit you. Hard. You’ve stretched your resources as far as you can, but you’re still on the ropes financially. The California eviction moratorium has been rolled back and your local eviction moratorium—the only thing protecting commercial tenants (in San Diego County and many others)–is about to expire at the end of September. The CDC has issued an order forbidding evictions until the end of the year, but only for residential tenants. Your landlord is waiting in the wings to be paid in full for the back rent you couldn’t afford to pay during the lockdown.

The b-word—bankruptcy—rears its head in your mind. But can you, as a business that is still federally illegal, file for bankruptcy—a creature of federal law?

One would think the answer is “absolutely not.” However, a relatively recent District of Colorado Bankruptcy Court ruling, and its soon-to-be progeny, may eventually provide a glimmer of hope for the distressed cannabis-adjacent business.

On April 20, 2020—a date not without significance for the cannabis industry—United Cannabis Corporation and its associated entity UC Colorado Corporation filed for bankruptcy in the District of Colorado. Shortly thereafter, on April 22, 2020, Bankruptcy Judge Joseph G. Rosania, Jr. issued an Order to Show Cause why the bankruptcy should not be dismissed, citing the rule that businesses whose operations constitute federal crimes cannot take advantage of the federal bankruptcy system. Arenas v. United States Tr. (In re Arenas), 535 B.R. 845, 847 (B.A.P. 10th Cir. 2015).

Despite this seemingly impassable roadblock, the debtors are hoping to take advantage of a narrow gap in the case law hinted at by an earlier bankruptcy case from the District of Colorado—In re Way to Grow, Inc., 610 B.R. 338 (D. Colo. 2019). In that case, the debtors were a group of business entities selling hydroponic agriculture equipment. On December 14, 2018, the Bankruptcy Court dismissed the petition, citing the fact that although hydroponic equipment can be used to grow any number of crops, the overwhelming majority of debtors’ sales were to cultivators. In re Way to Grow, Inc., 597 B.R. 111 (Bankr. D. Colo. 2018). The debtors appealed to the District Court, citing Congress’ passage of the Agriculture Improvement Act of 2018—also known as the 2018 Farm Bill—which legalized hemp on December 20, 2018, mere days after the Bankruptcy Court dismissed debtors’ petition. 610 B.R. at 355. The debtors argued that their products could have been used by their customers for the now-legal cultivation of hemp, as opposed to cannabis. Id. The court demurred, stating “[t]his Court does not opine on whether the timing of the Agriculture Improvement Act’s passage excuses Debtors’ failure to develop a proper record or to advance the argument” that “‘the legalization of hemp means that they could reorganize based on the hemp market.’” Id. at 355-56.

This brief discussion of the tension between federally illegal cannabis and federally legal hemp as it relates to bankruptcy eligibility left the door ajar for a debtor like United Cannabis. United Cannabis has filed a petition tailored to fit through that narrow gap, arguing that its chapter 11 reorganization can be funded by its non-cannabis income. United Cannabis argues that its $4 million bankruptcy estate is overwhelmingly derived from legal hemp/CBD business whose only cannabis-related holding is ownership of stock in WeedMD, a Canadian medical cannabis company whose shares are publicly traded in the United States.

In other words, United Cannabis has placed the exact question the District of Colorado dodged in Way to Grow squarely before the District of Colorado Bankruptcy Court: Can a company with some income derived from cannabis be allowed to file for chapter 11 bankruptcy if it can fully fund its reorganization without that cannabis-derived income?

As of now, that question remains unanswered. The debtor and the U.S. Trustee have filed their responses to the court’s OSC and now the parties—as well as industry watchdogs—eagerly await the court’s decision. The court’s ruling on the Order to Show Cause has been pending since mid-May 2020 and the court has allowed the bankruptcy to proceed as normal in the interim. Although the court itself has offered no timeline for when it will issue its decision on the Order to Show Cause, nor has it indicated why its decision has been pending for nearly four months, one can only speculate that the court may be waiting for guidance from Congress or elsewhere before issuing its decision. Moreover, the length of time that has elapsed since the parties in interest submitted their responses to the Order to Show Cause suggests that the court does not view the issue as a black-and-white one—or, at the very least, as a political hot potato.

Regardless of when the decision will be issued, if the court allows the debtors’ petitions to survive its OSC , it could be a watershed moment for businesses who service the industry in a small capacity by opening the door to bankruptcy relief, provided that they can fund their reorganization without cannabis money. However, the court could easily bypass this question just as the court did in Way to Grow. The U.S. Trustee, citing United Cannabis’ own marketing materials, argued in its response to the OSC that United Cannabis marketed itself largely as a cannabis company, not as a legal hemp/CBD company. Per the U.S. Trustee, United Cannabis had, in the recent past, identified numerous cannabis/THC products that it sold and distributed. If the court finds this evidence credible, it could easily find that United Cannabis is not entitled to bankruptcy relief because it cannot fund its reorganization with non-cannabis money, regardless of whether that route would be a viable path to bankruptcy.

COVID-19 has taken its toll on a wide swath of industries—including the “essential” cannabis industry. Despite this designation, cannabis businesses have been cut off from Paycheck Protection Program loans and bankruptcy, among other federal forms of economic relief. However, if the United Cannabis court decides that mixed hemp/cannabis companies can file for bankruptcy if they can reorganize without cannabis money, that pushes the cannabis industry an inch closer to enjoying the governmental benefits that its non-cannabis business counterparts enjoy.

Reading the Sativa Leaves: Between the Lines of the FDA’s Report to Congress on Hemp and CBD Testing

July 17, 2020/in All Blog Posts, Cannabis, Corporate Litigation/by Jake Ayres

On July 8, 2020, the United States Food and Drug Administration (FDA) recently issued a highly anticipated report to Congress regarding the results of its preliminary campaign of testing of cannabidiol (CBD) products on the market for both mislabeling and adulteration. Although the authors of the report were careful to include numerous caveats about the conclusions that can be drawn from the report[1], the report does provide some potential indications about the future of the industry.

In its report—mandated by the 2018 Farm Bill which federally legalized hemp and CBD derived from hemp—the FDA found, broadly speaking, that adulteration of CBD with potentially harmful chemicals like heavy metals and pesticides was not significant. On the other hand, the report indicated a potentially more widespread problem with mislabeling of CBD products—particularly so regarding inaccurate label representations of the amount of CBD contained in the product.

Overall, given the ocean of caveats that necessarily accompany it, the FDA report—read within its four corners—is not particularly illuminating. However, it could be a bellwether for the future direction of FDA regulation of hemp and CBD products. Despite the fact that the 2018 Farm Bill legalized hemp and hemp-derived CBD, the FDA’s sluggishness to adopt regulations has placed hemp and CBD businesses in an awkward legal netherworld. Hemp businesses often find financial institutions unwilling to lend to them, despite urging from industry groups and the 2018 Farm Bill’s congressional sponsors, because of the risks associated with banking for an as-yet unregulated industry.[2] Moreover, recent court decisions dismissing or staying litigation surrounding hemp and CBD businesses until the FDA issues its regulations pursuant to the “primary jurisdiction” doctrine have underscored the urgency for the FDA to take action. As a result, anticipating where the FDA will focus its regulatory and enforcement powers can be valuable for a hemp/CBD business looking to allocate limited compliance resources.

The FDA report collates two sets of testing performed by the FDA—“historical” testing from 2014 to 2018, conducted prior to the enactment of the 2018 Farm Bill, and testing from 2019 conducted in response to the enactment of the 2018 Farm Bill.

The historical testing was geared toward identifying the presence of various types of cannabinoids in CBD products on the market. Throughout the four-year period, the FDA selected 78 CBD products for inclusion in testing not on a random basis, but rather on several qualitative factors, including but not limited to: products that were widely available commercially, products that made strong health claims, and products about which the FDA had received complaints. A subgroup of 23 of the 78 CBD products were tested for consistency with their labels. Only eight of the 23 CBD products (35%) accurately stated on their packaging the amount of CBD they contained.

The FDA also tested these products for the presence of THC. THC presence rose and fell during the 2014 to 2018 period as follows: 2014 – 39%; 2015 – 83%; 2016 – 68%; 2017 – 25%; 2018 – 33%.

The 2019 study resulted from the FDA’s selection of 34 CBD products for testing both for cannabinoid content and for the presence of adulterants such as heavy metals. Like the historical studies, these products were not selected randomly, but were instead selected in response to “consumer and industry complaints . . . and [informed by] online surveillance.”

As for the adulterant testing, the FDA analyzed the 34 products for the presence of, among other things, heavy metal elements such as lead and arsenic. The FDA concluded that the “levels found in these 34 products did not raise significant public health concerns.”

As for the 2019 mislabeling testing, much like the historical testing, the FDA found evidence of CBD product packaging misstating the amount of CBD present in the product. The FDA tested 31 of the 34 products for cannabinoids. Of the 31 products, only 21 affirmatively stated the amount of CBD in the product. Of those 21 products, only seven (33%) stated the amount of CBD “within 20 percent of the amount indicated.” Furthermore, 48% of the 31 products tested for cannabinoids contained THC. However, despite what seem to be statistics indicating a widespread problem with labeling, the FDA was careful to include the disclaimer that “[t]he results obtained for these 34 products is from a limited sample size and cannot be used to draw definitive conclusions and further testing is warranted.”

The FDA also included a report on its in-progress 2020 testing, which the FDA has broken into “near-term” and “long-term” testing. This time, the FDA took a stab at randomizing its samples by purchasing 200 CBD products randomly selected from a 500-product list generated from the FDA’s online research. The FDA tested 147 of these 200 products for cannabinoids, while 133 of those 147 were also tested for arsenic, cadmium, mercury, and lead.

Consistent with the 2019 study, 132 of the 133 products tested were free of heavy metals. As for the labeling testing, of the 102 products that indicated a specific amount of CBD in their packaging, 18 products contained less than 80% of the amount of CBD indicated, 46 products contained CBD within 20% of the amount indicated, and 38 products contained more than 120% of the amount indicated. 72 of the 147 products contained THC or THCA above the .03% legal threshold imposed by the 2018 Farm Bill.

In particular, based on the results of its testing so far, the FDA seems likely to focus its regulatory and enforcement efforts on the recurring mislabeling issue. Although the studies summarized in the report were commissioned to evaluate concerns over both adulteration and mislabeling, the adulteration issue takes a definitive backseat in the FDA’s discussion because most samples tested by the FDA disclosed insignificant levels of heavy metal adulterants. The FDA’s data, however flawed, does show frequent mislabeling of the CBD content of the products. Having impliedly recognized this as a problem, the FDA now must choose how lenient to be to the CBD/hemp industry in drafting their regulations. That is, the FDA will likely draft a margin for error into the regulations regarding packaging and labeling claims for the concentration of CBD in a given product. The FDA could take its cues from the California regulations for THC content label claims and provide that a product is in compliance as long as the claimed CBD content is within 10% accuracy in either direction. 16 Cal. Code Regs. § 5307.1(a). However, the FDA could easily go above or below the 10% variance figure depending on the results of their further testing and/or political pressure.

Regardless of where the FDA’s regulations land, it seems clear that mislabeling of CBD concentrations will be top of mind for both regulators and plaintiffs’ attorneys. In light of that, hemp and CBD businesses should make sure to invest in reputable and repeatable testing to ensure that the actual CBD content of their products is as close as possible to the amount of CBD claimed on the product’s label or packaging.

[1] These difficulties in accurate measurements are in part a feature, not a bug, of the cannabis and hemp systems, because testing protocols in the industry are far from uniform and two tests of the same substance can generate widely varying results.

[2] However, FinCEN did recently issue guidance to the financial industry stating that Suspicious Activity Reports are not automatically required for transactions involving hemp business.

The CBD FAQ

December 8, 2019/in All Blog Posts, Cannabis, Corporate Litigation/by Jake Ayres

CBD, short for cannabidiol, is the wildly popular compound that has found its way into food, drinks, supplements, cosmetics, and even dog treats. CBD is a non-psychoactive instance of the 113 known cannabinoids, organic compounds unique to cannabis. Celebrity athletes have gotten into the game as well, with ex-Patriots tight end and lovable goofball Rob Gronkowski partnering with CBD Medic and North Shore cult hero professional surfer Jamie O’Brien extolling the virtues of the CBDMD line of products on his Instagram page. CBD’s proponents cite its purportedly therapeutic effects, ranging from analgesic, anti-inflammation, anti-anxiety, and mild sedation. Some proponents have even used the term the “boy scout molecule” to describe its positive effects because it always “does the right thing.”

Although the FDA has only approved CBD in the context of clinical trials for the drug Epidiolex—used to treat a form of epilepsy—the market interest in CBD, derived in part from the anecdotal reports of its benign and benevolent bodily effects, has skyrocketed in the recent past. In fact, the cannabis industry market research firms BDS Analytics and Arcview Market Research estimate that the CBD industry could reach a value of $20 billion by 2024. In spite of the overwhelming public interest and market demand, one question remains: is it legal? In the article below, we answer the fundamental frequently asked questions about the current, hazy legal framework.

FAQ:

IS CBD LEGAL AT THE FEDERAL LEVEL?

IS CBD LEGAL UNDER CALIFORNIA LAW?

CAN YOU PUT CBD IN FOOD OR DRINKS?

CAN I DEPOSIT FUNDS FROM HEMP-DERIVED CBD WITH A BANK? CAN I GET A BANK LOAN FOR MY HEMP-DERIVED CBD BUSINESS?

WHAT’S NEXT?

Is CBD legal at the federal level?

Yes—if it is derived from hemp, not cannabis. The Agriculture Improvement Act of 2018 (the “Farm Bill”) passed by Congress revised Controlled Substances Act to differentiate between the plants cannabis and hemp. Without delving too deep into botany and plant genetics, generally speaking, hemp is the same species as cannabis sativa, but has little to no psychoactive properties—that is, a very low proportion of delta-9 tetrahydrocannbinol (THC).

Indeed, the Farm Bill defines hemp as “the plant Cannabis sativa L. and any part of that plant, including the seeds thereof and all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers, whether growing or not, with a delta-9 tetrahydrocannbinol [THC] concentration of not more than 0.3 percent on a dry weight basis.” Because the plant is itself legal, that has paved the way for the nationwide legality of CBD, provided it is derived from a hemp plant.

That being said, the Farm Bill also provides that hemp-derived CBD, as well as the hemp plants themselves, are subject to relatively strict state-federal oversight, where hemp cultivators, in states like California that have opted to develop a hemp program, must apply for licenses from state departments of agriculture who have submitted an approved plan to the United States Department of Agriculture. Cultivators in states that have opted not to develop a hemp program must apply to the federal government for licenses to grow.

The penalty for cultivators that grow a crop that is out of compliance—that is, one that contains more than 0.3% THC—is the harsh remedy of mandatory destruction of the entire crop. This legal regime has brought into relief the climate sensitivity of hemp, in that seeds grown in one state can generate a crop coming in under the 0.3% threshold, while identical seeds grown in a different state can result in a non-compliant crop subject to destruction. As the science on the plant develops, hemp cultivators will continue to have to bear the risk of these variations in THC content as long as cannabis and THC remain federally illegal.

Is CBD Legal under California Law?

Yes. Nothing earth shattering here, but a foundational point that puts California at odds with federal law once again. Now that cannabis has been legalized for recreational use in California, the whole plant, including CBD derived from cannabis, is now legal at the state level (provided the parties in the supply chain have the proper licensure, of course).

However, cannabis is still federally illegal. CBD derived from cannabis, as opposed to hemp, is still federally illegal, placing CBD in the same legal netherworld as California-legal cannabis and THC. That is, businesses and individuals that grow, manufacture, process, distribute, sell, and consume cannabis, even in states where it has been legalized for adult-use/recreational purposes, are still breaking federal law, which considers cannabis a Schedule I drug under the Controlled Substances Act.

However, there is a measure of protection for medical cannabis operators. Under the Ninth Circuit’s decision in United States v. McIntosh, 833 F.3d 1163 (2016), the federal government is prohibited from prosecuting individuals or entities for medical cannabis usage or distribution, provided that those same persons are in compliance with applicable state medical cannabis laws. Id. at 1177. In that case, the Ninth Circuit ruled that then-entitled Rohrabacher-Farr Amendment (now known as the Rohrabacher-Blumenauer Amendment)—a Congressional rider on appropriations bills that prevents the federal government from using federal funds to prosecute state law-compliant individuals or entities for cannabis usage/possession/distribution in states where medical cannabis is legal—was a binding prohibition on federal drug law prosecution against legal medical cannabis operators and consumers. The Rohrabacher-Blumenauer Amendment is currently in effect until September 30, 2020, having been renewed via the 2020 Fiscal Year omnibus spending bill on December 20, 2019.

However, the Amendment provides no protection from prosecution for recreational, as opposed to medical, cannabis. Although a broader version of the Rohrabacher-Blumenauer Amendment, which would have extended protection to recreational cannabis usage as well as medical cannabis usage, passed the House in June of 2019, the Senate refused to consider that expansion. On the other hand, the Cole Memorandum (“Cole Memo”), a now-defunct relic of the Obama administration, did provide some measure of protection for recreational cannabis, wherein the then-U.S. Attorney General James Cole in August 2013 instructed the DOJ to de-prioritize prosecution of cannabis cases, provided that the would-be defendants were in compliance with locally-enforced state law requirements. Of course, the Cole Memo explicitly stated it did not create any substantive civil rights or reduce the powers of the DOJ to prosecute cannabis cases, but instead provided prosecutorial guidelines. Although ostensibly geared toward avoiding prosecution of medical cannabis, the Cole Memo itself made no such distinction, referring to “jurisdictions that have enacted laws legalizing marijuana in some form,” and came after the first wave of recreational legalization in 2012 in Colorado and Washington. Regardless of the erstwhile Cole Memo’s scope, the vehemently anti-cannabis former Trump Administration U.S. Attorney General Jeff Sessions rescinded the Cole Memo with a one-page memorandum of his own in 2018.

Ultimately, the current administration has shown relatively little intention of prosecuting recreational cannabis. Sessions’ successor, William Barr, is less dogmatic about cannabis and its enforcement, and favors a “federalist” approach where the federal government would cede enforcement power and responsibility to the states. Barr even went as far to say that he “accept[s]” the Cole Memo, but has yet to reinstate it with a memorandum of his own, preferring to delegate the discretionary authority to individual U.S. Attorneys.

Until the federal government speaks more concretely, as of now, the only thing protecting legitimate cannabis businesses, even if their only product is non-psychoactive CBD (derived from cannabis, not hemp), are the whims of the local U.S. Attorney. However, California legitimate cannabis businesses can take some comfort in the fact that two of the four California U.S. Attorneys—Robert Brewer of the Southern District of California and McGregor Scott of the Eastern District of California—have made neutral-to-positive remarks regarding their enforcement priorities and personal attitudes toward cannabis, while the other two have remained sphinxish on the matter.

Can you put CBD in food or drinks?

Not right now, per the FDA. The FDA regulates food and drink in interstate commerce, and currently prohibits infusion of CBD into human or animal food or drink, citing the dearth of research on the toxicity of the molecule. However, this status is subject to change, as researchers within and without the FDA continue to explore the effects of CBD on humans and animals.

In fact, despite the widespread availability of CBD-infused food and drink products, the FDA has recently begun to assert its authority. On November 25, 2019, the FDA issued a press release announcing that it had “issued warning letters to 15 companies for illegally selling products containing [CBD] in ways that violate the Federal Food, Drug, and Cosmetic Act (FD&C Act).” The warning letters cited the 15 companies for various violations of the FD&C Act, including “marketing CBD products to treat diseases or for other therapeutic uses for humans and/or animals” and “marketing CBD products as dietary supplements and adding CBD to human and animal foods.” In so doing, the FDA noted that “it cannot conclude that CBD is generally recognized as safe . . . among qualified experts for its use in human or animal food.” The FDA cited back to its prior consumer update, where it pointed out the results of several preliminary studies indicating potential negative effects of CBD, including but not limited to liver damage. In short, the FDA continues to rely on the absence of reliable science on the effects of CBD in justifying a conservative approach to the legal regime surrounding CBD infused food and drink. More importantly for operators in the hemp and CBD industries, the FDA has shown that is not afraid to crack down on those who would flout the prohibition on CBD-infused food and drink. Whether these warning letters lead to prosecution for the 15 businesses or their competitors, however, remains to be seen.

Can I deposit funds from hemp-derived CBD with a bank? Can I get a bank loan for my hemp-derived CBD business?

Unclear. The federal government and the banking industry are engaged in an ongoing ping-pong match wherein Congress urges banks to accept hemp money, and the banking industry responds by requesting additional guidance from the federal government.

The initial volley came in April 2019 where Senators Mitch McConnell and Ron Wyden sent letters to banking regulators urging them to issue guidance so that banks would “feel secure in engaging” with the hemp industry, but also noting that “[l]egal hemp businesses . . . should not [be] discriminated against.” The American Banking Association sent a follow-up letter to financial regulators in June 2019 similarly urging for issuance of guidance to the banking industry such that they would be empowered to accept money from legal hemp businesses.

On December 3, 2019, federal banking regulators responded by confirming that they would not require federally insured banks to file suspicious activity reports for hemp business clients. In so doing, they confirmed that hemp is no longer considered a Schedule I controlled substance, and that hemp business customers are responsible for compliance with the regulatory framework put forth by the Farm Bill. Despite this reassurance, the ABA responded positively to the announcement, but stopped short of announcing it was open season for hemp business loans, noting that they would work with regulators to “develop additional guidance.” In short, although federal regulators and the banking industry are closer to reaching consensus on providing financial services to hemp businesses than they were in early 2019, the banking industry has not indicated that they are entirely open for business. That being said, the rollback of the suspicious activity reports rule perhaps paves the way for more risk-tolerant financial institutions to jump into servicing the hemp industry while the more conservative wing of the industry waits for additional federal guidance and assurances.

What’s Next?

The legal framework for CBD, much like that of cannabis more broadly, has yet to catch up to the market demand. Because of the potential pharmaceutical, food, and drink applications of CBD, the FDA has taken the lead on its regulation, holding a public hearing from various stakeholders at the end of May 2019. The FDA has not yet issued further rules or guidance since then, presumably to digest the numerous comments made at that day-long hearing. Until then, hemp-derived CBD is safely in the stream of commerce, as long as it is not in food or drink. Cannabis-derived CBD is in the same legal purgatory as California-legal cannabis, but may benefit from the same amount of prosecutorial discretion. As far as your favorite CBD lemonade your local liquor store stocks, that product is in jeopardy of being taken off the shelves, as demonstrated by the FDA’s November warning letters.

In the Weeds on the SAFE Banking Act

May 20, 2019/in All Blog Posts, Cannabis, Corporate Litigation/by Jake Ayres

In tax season of 2019, a legal cannabis grower walked a nerve-wracking 20 yards from the parking lot to a California government office to pay his state taxes—with a pile of $350,000 in cash. The illegality of cannabis at the federal level has largely shut cannabis businesses—legal at the state level—out of traditional banking. As a result, cannabis businesses operate on an all-cash basis, leading to cash payments to employees, vendors, professional service providers, utilities, and government entities. While this has been a boon to the armored transport and logistics industries, cannabis businesses striving to remain within the contours of the law find themselves bearing the considerable burdens of operating on an all-cash basis, racking up considerable overhead to protect large sums of cash from would-be thieves. Given the onus placed on cannabis businesses—and, arguably, neighbors wary of 24/7 armed guards—cannabis business surely cannot remain excluded from banking forever, can they? Enter the Secure And Fair Enforcement (SAFE) Banking Act of 2019

This Act would open the federal floodgates holding back a swollen river of cannabis money, allowing cannabis business to bank their money with traditional financial institutions. The SAFE Banking Act, cosponsored by a bipartisan group of 180 representatives, has already been approved for a U.S. House of Representatives floor vote after passing the House Financial Services Committee on March 28, 2019, with a 45 to 15 vote. On April 8, 2019, the House Judiciary Committee referred the bill to the House Committee on Crime, Terrorism, and Homeland Security, where it has not yet received a vote. A week later, companion legislation was reintroduced in the Senate. On May 9, the attorneys general of 33 states (along with Washington D.C. and four U.S. Territories) sent a letter to Congress to advocate for the bill’s passage, arguing that “the reality of the [cannabis industry] requires federal rules that permit a sensible banking regime for legal businesses.”

The SAFE Banking Act would provide safe harbor for financial institutions to accept money from “cannabis-related legitimate businesses” (“CRLBs”)—that is, cannabis businesses that are in compliance with the applicable state law regime—in that they would be immunized from adverse federal action, whether by federal regulators or prosecutors. The bill would also immunize funds derived from state-legal cannabis transactions from the federal money laundering statute. Finally, the bill also would immunize collateral interests held by banks in loans provided to the cannabis industry from asset forfeiture, making possible bank foreclosures on cannabis business assets, such as farms or other real estate.

The bill also goes beyond CRLBs to provide banking access to “service providers” to the cannabis industry. The bill’s definition of “service provider” is broadly worded to include any business that “sells goods or services” to a CRLB, and explicitly includes real estate professionals, lawyers, and “other licensed services”—e.g. CPAs. In particular, the bill would extend the safe harbor and money laundering exemptions to funds deposited by service providers in addition to CRLBs. In other words, the vendors and professionals providing services to the cannabis industry would also be allowed to bank money derived from their cannabis industry clients with financial institutions. This would be a financial security blanket for the notoriously risk-averse legal profession, although California lawyers have already obtained a measure of protection with the November 2018 amendment to California Rule of Professional Responsibility 1.2.1, which allows California attorneys to counsel legal California cannabis businesses, provided that they advise said business regarding federal illegality.

The House Financial Services Committee passed several amendments to the SAFE Banking Act that alter its scope. Representative Steve Stivers successfully proposed an amendment that explicitly included insurers of CRLBs as a class of businesses to which banks can provide financial services. Representative Ed Perlmutter also successfully proposed several amendments, the most significant of which broadened the definition of “financial services” in the bill to include armored car services and “money transmitting businesses,” which would presumably open the door to cannabis transactions via PayPal, Venmo, and Western Union.

Although the SAFE Banking Act’s House floor debate does not yet have a set date, the bipartisan support in the House, along with the support of a majority of the states attorneys general, suggests that it may pass the House. However, the Senate Banking Committee chair, Senator Mike Crapo, has openly stated his opposition to his committee’s considering the bill. However, legislative 180s on cannabis are not unheard of, such as former Speaker of the House and cannabis opponent John Boehner’s sudden support for cannabis legalization after joining the board of cannabis company Acreage Holdings. The SAFE Banking Act would provide relief for a cannabis industry eager to pay its employees and taxes electronically, and would also enervate financial institutions with the munchies for cash from the $16 billion legal U.S. cannabis industry. Although the legislation remains a possibility rather than a reality, the traction and bipartisan support the bill has received suggests that legalized banking for cannabis industry funds is a question of “when” rather than “if.” Regardless of its ultimate success, the SAFE Banking Act merits monitoring by the cannabis and financial sectors such that they can be prepared for the coming changes to their respective industries. In any case, the days of grocery bags full of cash as tax payments seem untenable in the long term.