Legal Actions That Insurance Pros in the Cannabis Biz Should Pay Attention to

May 18, 2020
Ian Stewart

Lawsuits and legal concerns in the cannabis business are too numerous to count – just like with many other industries – but there are few that insurance professionals in the business should keep an eye on, according to cannabis legal expert Ian Stewart.

Stewart, a partner in Wilson Elser Moskowitz Edelman & Dicker LLP, offered his take on three ongoing legal matters of importance and what the insurance industry should takeaway from them.

1. Federal Grand Jury Targets Weedmaps and Others

A federal grand jury subpoena that was made public in March 2020 has raised the question of whether the U.S. Department of Justice will be taking a more aggressive enforcement posture against the cannabis industry.

The subpoena was issued in September 2019 to the parent company of California-based Weedmaps, the online directory of cannabis retailers and delivery services. Weedmaps made news in 2018 when it was accused by California state regulators of “aiding and abetting in violations of state law” by advertising unlicensed and illicit operators. Weedmaps changed its practice in January 2020 and now requires all companies that advertise on its site to list a license number.

The grand jury subpoena appears to be an attempt to determine whether Weedmaps, other companies and state officials have complied with state cannabis regulations and other laws. The subpoena orders production of records pertaining to dozens of licensed and unlicensed companies and individuals, including numerous well-known cannabis retailers, distributors and brands. It also includes a demand for records related to communications and payments to state and federal employees and elected officials.

The Takeaway for the Insurance Industry

The case is a reminder that for anyone operating in the commercial cannabis sector, compliance remains the cornerstone of risk management. It has been more than two years since the DOJ’s Cole Memo (essentially stating that DOJ would not prosecute state-compliant marijuana-related activity) was rescinded, yet no federal enforcement actions have been reported where the sole basis for the action is commercial cannabis activity within a state-regulated market. This lack of enforcement activity may have resulted in some elements within the cannabis industry lowering their guard on compliance. In light of the Weedmaps grand jury subpoena, the time may be coming where the DOJ throws down a cautionary gauntlet by making an example of cannabis industry players who have pushed the boundary too far in the eyes of the federal government. Carriers would be wise to take note and watch closely how this matter develops.

2. Nevada Federal Court Throws Enforceability of Cannabis-Related Contracts into Doubt

Federal courts have increasingly ruled on disputes arising out of the cannabis industry or applied federal statutes to cannabis-related matters. There is a strong trend toward the enforcement of contracts and other rights of cannabis industry litigants in federal court. An order entered in April 2020 by the Nevada District Court, however, raises concerns because the court refused to enforce a loan agreement that was legal under Nevada state law on the basis that it violates the Controlled Substances Act (CSA).

Bart Street III v. ACC Enterprises LLC et al. arises from the defendant’s alleged breach of a multimillion-dollar loan contract to finance the expansion of the defendant’s marijuana cultivation business in Nevada. A portion of the loaned amount was earmarked toward operating capital, and the plaintiff was granted a first right of refusal to obtain shares in the defendant’s entities. When the defendants failed to repay the loans, the plaintiff sued in the Nevada District Court for breach of contract and unjust enrichment. The defendants argued that they could not be held liable for breach of a contract that is illegal under the CSA.

In an order dated April 1, the federal court refused to enforce the contract by finding that the right of first refusal and operating capital terms violated the CSA because the right of first refusal term would have allowed the plaintiff to profit from the sale of marijuana, and the operating capital provision provided direct assistance to the defendants’ cultivation of marijuana. The court further noted that it is irrelevant that marijuana is legal under Nevada state law because the CSA preempts Nevada law under the Constitution’s Supremacy Clause.

The court also rejected the plaintiff’s claim for unjust enrichment, noting that allowing recovery for unjust enrichment “would undermine enforcement of federal law by giving prospective investors increased confidence in funding marijuana businesses.” The court further rejected the unjust enrichment claim on the basis that the parties’ contract involves “moral turpitude.” Apparently anticipating a negative public reaction to this conclusion, the court took the precaution of explaining that “it is not the job of the court to weigh the policy considerations behind federal marijuana prohibition against Nevada law and the growing trend of state ‘legalization.'”

The Takeaway for the Insurance Industry

Insurers should understand the difference between how federal agencies and the federal courts are responding to the growth of state commercial cannabis markets. Federal policy regarding enforcement of the CSA has shown ambivalence where the possession and distribution of marijuana is consistent with well-regulated state law. Some federal courts, however, take a nuanced but strict position with respect to enforcement of cannabis-related contracts and other rights by evaluating whether enforcement would require the litigant to actively violate the CSA.

For example, various federal courts have enforced cannabis-related contracts pertaining to insurance, federal labor and employment statutes, federal intellectual property protections, and contracts around ancillary products and services. In those cases, the courts determined that enforcement of the contract or right would not result in the litigant directly profiting off of the possession, cultivation or distribution of marijuana. Consistent with several prior federal court decisions, however, the Nevada District Court in the Bart Street decision has drawn a line where enforcing the contract would mandate violation of federal law. This decision raises questions on where the line is drawn for enforcing a contract in federal court. This has deep implications for every cannabis stakeholder, including their insurers.

‘The case is a reminder that for anyone operating in the commercial cannabis sector, compliance remains the cornerstone of risk management.’

3. A Unifying Strategy for Defending CBD Class Actions

The number and frequency of CBD class actions are increasing. It is predictable that each new round of FDA warning letters will be followed closely by class action complaints. Many cases have been filed by the same small handful of plaintiffs’ law firms and most of the complaints make similar legal claims, including (1) that the CBD products are illegal drugs, foods or supplements under FDA guidelines; (2) that the products make impermissible health or disease claims; or (3) that the products are mislabeled in terms of their CBD content. These lawsuits seek to shut down the entire industry one company at a time.

The law firms that defend these lawsuits, including the author’s, raise similar legal defenses. This means that courts across the country now are being asked to rule on very similar legal issues that are critical to the future of the CBD industry. The stage is set for potentially inconsistent legal rulings and additional confusion as to the legality of CBD products, which the industry and the public can ill afford.

Currently, most CBD class actions are being defended by arguing that the FDA has primary jurisdiction over the regulation of CBD, and that the courts should therefore refrain from making inconsistent piecemeal rulings. The primary jurisdiction doctrine permits courts to stay or dismiss litigation pending resolution of an issue within the special competence of an administrative agency.

On Jan. 3, a Florida district court stayed a case involving CBD products based on the primary jurisdiction doctrine pending guidance by the FDA. In Snyder v. Green Roads of Florida LLC, the court concluded that the current regulatory framework is inadequate to resolve the issues posed by the case. The court concluded that “FDA regulations currently provide little guidance with respect to whether CBD ingestibles, in all their variations are food, supplements, nutrients or additives and what labeling standards are applicable to each iteration.” Several other courts around the country are currently considering similar arguments in pending motions.

Adding to the urgency is the recent acknowledgment by current FDA Commissioner Stephen Hanh that CBD products are here to stay. On Feb. 26, Hahn stated: “People are using these products. We’re not going to be able to say you can’t use these products. It’s a fool’s game to try to even approach that.” The FDA issued an updated report to Congress in March 2020, and is due to report the results of a CBD labeling study in June, though there may be a delay due to the ongoing disruptions from coronavirus.

The Takeaway for the Insurance Industry

Insurers should continue to proceed with caution when it comes to CBD products, which are the subject of many more lawsuits and more regulatory uncertainty than their THC-containing cousins in the marijuana industry. There is nevertheless reason for optimism. The basis of many CBD class action complaints – that the CBD products are broadly “illegal” throughout the United States – is overstated. FDA simply has not engaged in the final, formal rulemaking process that establishes a regulatory structure that carries the force of law. Rather, the FDA is at a much earlier stage in the process. It is working with industry and other stakeholders to gather data and determine how it should regulate the industry. In the meantime, uncertainty creates risk and opportunity for the CBD insurance industry.

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