As many cannabis business operators know, the continued federal prohibition of cannabis causes a number of headaches in the day-to-day operations of their businesses. One such headache that operators may not be aware of is the enforce-ability of contracts related to the sale or production of cannabis itself.
California law requires that all contracts have a “lawful object.” Contracts that require the parties to engage in illegal activity (for example, a contract to rob a bank) have an “unlawful purpose” and are therefore void and unenforceable in a court of law. Before January 1, 2018, contracts for the sale, manufacture, or transfer of cannabis products had an “unlawful object” because cannabis and its byproducts remain illegal under the federal Controlled Substances Act (“CSA”), even though cannabis was legal at the state level. As a result, parties seeking to avoid their responsibilities under contracts with cannabis businesses often argued that their contracts were void and unenforceable, and both state and federal courts would, in turn, refuse to honor such contracts.
Thankfully, on January 1, 2018, California enacted Civil Code Section 1550.5, which unequivocally states that cannabis-related contracts have a lawful object under California law, so long as they are “conducted in compliance with California law and any applicable local standards, requirements, and regulations.” Accordingly, if a cannabis contract entered into after January 1, 2018, complies with all applicable cannabis regulations and is otherwise enforceable, California state courts need not render it unenforceable under the unlawful object doctrine.
However, cannabis business operators still face risks for contracts drafted prior to January 1, 2018. For example, in Susan Metsch et al. v. Jesse Heinowitz et al., the court refused to enforce a contract that was entered into in 2014, when cannabis was not yet legal for recreational use in California. In that case, the plaintiffs alleged that the defendants breached a contract for the production and distribution of edible cannabis products. The trial court held that the plaintiffs could not enforce the contract because the cannabis business they operated was illegal at the time they entered the contract, and that they therefore had no right to seek enforcement of a contract based on an illegal transaction, i.e., an “unlawful object.” The appellate court affirmed this holding, emphasizing that a contract must be lawful at the time it is made and that courts must apply the law in effect at the time the parties entered into the contract at issue. This holding underscores the importance of reviewing past contracts to evaluate whether they should be revised or replaced so that they comply with state law.
Additionally, it should be noted that Civil Code Section 1550.5 has no effect on federal courts. For example, in Left Coast Ventures, Inc. v. Bill’s Nursery, Inc., Left Coast Ventures, Inc. (“Left Coast”) claimed that Bill’s Nursery, Inc. (“Nursery”) reneged on Left Coast’s option to purchase the Nursery. In response to a motion to dismiss brought by the Defendants, a Washington federal court independently questioned the validity of the contract, reasoning that although Washington law governed the breach of contract claim, “where it is alleged that an agreement violates a federal statute, [federal] courts look to federal law,” rather than applying the substantive law of the state. Although the Court ultimately abstained from ruling on the Plaintiff’s Motion to Dismiss, the order at least suggests that federal courts may continue finding cannabis contracts unenforceable regardless of their validity under state laws and regulations. Therefore, cannabis business operators should take care to draft contracts so that they avoid the jurisdiction of federal courts.
Cannabis business operators have several options relative to minimizing the risk that a court will deem a contract unenforceable. But identifying the optimal course of action inevitably depends on the unique circumstances surrounding a given contract. Accordingly, owners of cannabis businesses are advised to seek legal counsel regarding the enforce-ability of their contracts and, in the event a contract is at risk of being deemed unenforceable, the various measures available to mitigate against such risk (e.g., including a choice of law provision or a provision that otherwise states that California law shall apply as to all issues of enforceability).
The lawyers at Huguenin Kahn are experienced and skilled in contract drafting, interpretation and litigation, and ultimately stand ready to assist you with all your legal needs. Please call us at (916) 367-7098 or e-mail us at info@hkcannabislaw.com. You can also follow us on social media at @hugueninkahn and @hkcannabislaw, and please visit our websites at hugueninkahn.com and hkcannabislaw.com.