Drafting Contracts for Cannabis-Based Businesses

Introduction

Contracts for cannabis-based businesses present unique challenges, and as Illinois prepares to legalize the recreational use of cannabis next year, these businesses and their counsel must deal with them. Particularly difficult will be the interaction of Illinois and federal law, for even in those states which have long since legalized cannabis, the federal Controlled Substances Act (“CSA”) still considers it a banned substance.

The Left Coast Ventures Case

A recent Washington case is illustrative. The State of Washington legalized cannabis seven years ago, but a federal district court there recently signaled it may hold a cannabis contract unenforceable. While not precedential in Illinois, the case could signal how federal courts in Illinois will examine cannabis contracts.

In Left Coast Ventures, Inc. v. Bill’s Nursery, Inc. (case no. 2:19-cv-01297), plaintiff Left Coast Ventures (“Left Coast”) alleged that defendant Bill’s Nursery, Inc. (“Bill’s Nursery”) breached an option agreement in which Left Coast had an option to purchase Bill’s Nursery. Left Coast maintains that Bill’s Nursery reneged on the agreement and filed suit. The lawsuit was originally filed in Washington state court but was removed to federal court based on diversity jurisdiction. Recently, Judge Marsha Pechman issued an Order to Show Cause (“Order”), in which the parties have to show why the court should not dismiss the case. If the parties cannot show cause under the Order, the case will be dismissed based on the contract’s unenforceability.

The Order states that the contract may be unenforceable under the CSA because it concerns cannabis businesses, and cannabis remains an illegal substance under the CSA. Even though federal courts must follow state substantive law under the long-standing Erie doctrine, and so typically the court should apply Washington law to this breach of contract claim, Judge Pechman stated:

Although Washington law governs the breach of contract claim, “where it is alleged that an agreement violates a federal statute, courts look to federal law.” Polk v. Gontmakher , No. 2:18-CV-01434-RAJ, 2019 WL 4058970, at *2 (W.D. Wash. Aug. 28, 2019) (citing Kelly v. Kosuga , 358 U.S. 516, 519 (1959) (“the effect of illegality under a federal statute is a matter of federal law”).

Polk v. Gontmakher was a prior cannabis contract case in Washington that was dismissed earlier this year on similar grounds. Having two such cases dismissed on similar grounds within months of each other is an ominous signal to cannabis-based businesses to avoid litigation concerning their contracts in federal courts, at least in Washington.

Conclusion: Anticipate the Unenforceability Issue and Draft Accordingly

While it remains to be seen how Illinois courts will respond, it is not difficult to imagine Illinois federal courts citing these cases in determining that such contracts are unenforceable due to the illegality of cannabis under federal law. How should cannabis businesses and their counsel respond? Until then, we advise that contracts involving cannabis companies should contain provisions whereby the parties acknowledge the illegality of cannabis under federal law and covenant that they agree not to raise the argument of enforceability in litigation.

If you have any questions about this article or have questions relating to cannabis-based businesses in Illinois, contact attorney Steven Migala at 847-705-7555 or smigala@lavellelaw.com.