We’ve previously written about some of the pitfalls for landlords to avoid when leasing to commercial cannabis tenants in California. We’ve also written about how the state’s recently proposed modifications to its final cannabis regulations could affect licensees and the industry writ large (see here, here, and here). The comment period for those rule changes is now over and we expect to see final rules from the state agencies within the next couple of weeks. This post focuses on a few examples of how those proposed modifications would affect cannabis landlords specifically.
One of the biggest proposed changes in the new rules has to do with who qualifies as an “owner” or a “financial interest holder” of a cannabis licensee that must be disclosed and vetted as part of the cannabis operator’s license application. Under the current proposed final rules and existing statutes, all “owners” of a cannabis business licensee must be listed in a licensee’s annual license application, including each owner’s contact information, social security number and tax identification number, employment information, disclosure and description of all past convictions, and a live scan fingerprint analysis for a background check with the Department of Justice. All “financial interest holders” in a licensee business must also be disclosed, though disclosure requirements are lesser than for owners and vary slightly across agencies, ranging from a simple list of financial interest holders to the name, and type and number of government identification for individuals; business name and tax ID for entities.
Under the most recently proposed rule modifications, a “financial interest holder” in a cannabis licensee such as a retailer, distributor, testing laboratory, or microbusiness would now include “[a] landlord who has entered into a lease agreement with the commercial cannabis business for a share of the profits.” And if that agreed share is 20 percent or more of the tenant’s profits, then the landlord would qualify as an “owner” of the cannabis licensee. (Landlords already qualify as “owners” under prior versions of the rules if they own 20 percent or more of the cannabis tenant business).
While we have previously written about the problems associated with landlords entering into anything other than an arms-length relationship with cannabis tenants for payment of rent in exchange for leased space, you can now add to that list the regulatory burden of disclosure and vetting of the landlord. However, if the landlord is an entity such as a holding company or an investment fund, the disclosure burden is amplified exponentially: if an entity landlord is an “owner” or a “financial interest holder” in certain kinds of cannabis licensees, then the same disclosure requirements apply for various layers of ownership to all individuals and entities that are owners or financial interest holders in that landlord entity, along with board members, CEOs, etc., all the way up the chain until only individuals remain.
What this means is that if cannabis landlords agree to accept a share of the tenant’s profits in lieu of rent—and this is not an uncommon arrangement especially for smaller or undercapitalized cannabis tenants—the landlord and its owners and investors could unknowingly be exposing themselves to unexpectedly high burdens of regulatory disclosure and vetting that would not normally apply if the tenant was anything other than a cannabis licensee.
It remains to be seen what the state agencies’ final rules will look like, especially in light of the widespread effect such disclosure requirements would have on investment in the cannabis industry in California, but in the meantime landlords considering profit-sharing arrangement with their cannabis tenants would be wise to consider the full regulatory implications of doing so, even if on an anticipated basis during pendency of the rulemaking process.
For more on California cannabis leasing, check out the following: