By Rehman Bhalesha, Baker Institute
This article originally appeared in The Baker Institute Viewpoints Series on November 6, 2014.
One of the many problems created by the conflict between federal and state marijuana law is uncertainty in the enforceability of certain contracts. Judges can, and in cannabis cases often do, void contracts for violating federal policy. Attendees at the Marijuana Investment Conference in Houston voiced their concerns about the possibility of federal law inhibiting the growth of a legal marijuana industry. At the conference, a Baker Institute and South Texas College of Law collaborative survey found that investors and entrepreneurs view the “risk of federal law superiority” and “legislative roadblocks” as among the greatest challenges faced by the marijuana industry.
Investors, financiers and entrepreneurs may achieve great success by participating in the growing field of cannabis commerce. Yet an improperly drafted contract agreement could hinder the sustainability of a successful business or investment. By reviewing cases and laws that address cannabis contract enforceability and researching ways to craft viable agreements in their cannabis-related transactions, investors, financiers and entrepreneurs can better navigate the marijuana marketplace. Although not an exhaustive review, the following cases reveal the challenges of enforcing cannabis contracts.
In 2010, financiers agreed to loan $500,000 to an Arizona medical marijuana business. The company eventually defaulted on the loan obligation. The financiers sued the defaulting business. In 2012, an Arizona Superior Court ruled in summary judgment against the enforceability of a marijuana-related loan agreement. The judge stated that since the purpose of the agreement, which was to finance the sale and distribution of marijuana, violates federal law, the “contract is void and unenforceable.”
In 2013, a court in California ruled in a similar manner. When a medical marijuana business failed to honor a contract calling for investment in exchange for profits, the investor sued the business in a California Superior Court. The judge ruled that the purpose of the contract was “illegal under applicable federal law” and thus the investment agreement was an “illegal and unenforceable contract.”
In Colorado, an initial court ruling was similar to case decisions in Arizona and California dealing with cannabis contract enforceability. In the Colorado case, a medical marijuana cultivator agreed to deliver product to a marijuana retailer. The cultivator claimed he never received compensation and sued the retailer in a Colorado District Court. The District Court judge concluded “contracts for the sale of marijuana are void as they are against public policy.” As of August 2012, courts followed the trend of viewing contracts as unenforceable when cannabis is involved, as seen in Arizona, California and Colorado.
However, a second cannabis contracts case in Colorado differed significantly from past rulings on the issue. In October 2012, a case regarding the issue of cannabis contract enforceability resulted in a favorable ruling for those advocating for marijuana agreement viability. Despite the defendant in the case arguing contract unenforceability under federal law, the judge rejected the defendant’s argument as unpersuasive. The defendants took the case to the Colorado Court of Appeals, where it is currently pending. In addition to the District Court victory supporting the validity of cannabis contracts, the Colorado General Assembly also worked to improve the chances of cannabis contract enforceability. The General Assembly passed a law, effective May 28, 2013, stating that under Colorado’s public policy, “a contract is not void or voidable as against public policy if it pertains to lawful activities authorized by” Colorado’s constitutional and statutory marijuana law.
In light of these legal developments, individuals involved in state-legal cannabis commerce must cautiously negotiate and craft their business agreements. Certain legal professionals familiar with the marijuana industry draft their marijuana-related agreements to obligate dispute resolution in the state where the marijuana business conducts its operations. They urge contracting parties not to subject their agreements to state and federal jurisdictions that prohibit marijuana businesses. They also recommend inserting provisions in cannabis contracts known as a “forum selection clauses” that limit where parties can file lawsuits. They further advise the parties to a cannabis contract to waive the right, if any such right exists, to take contract claims to federal courts. Federal courts to avoid, since they may hold a cannabis contract as unenforceable, include bankruptcy courts and federal district courts. Though federal and state law dichotomies create a lack of clarity, certain cannabis professionals rely on well-drafted agreements to provide predictability in an otherwise uncertain environment.
The federal government’s outdated marijuana policy sharply conflicts with the modernization of marijuana law sweeping the nation. Contract law does not protect cannabis transactions at the federal level. Therefore, state legislatures would be wise to follow Colorado’s example and pass statutory safeguards for cannabis contracts once the state updates its laws to allow for medical and recreational cannabis consumption. Investors, financiers and entrepreneurs involved in cannabis commerce should be cognizant of the issues surrounding contract enforceability and exercise prudence when entering into agreements.