Medical marijuana nursery. Photo: Shutterstock

Over the past five years, the legalization of recreational cannabis has swept across a significant portion of the country, bringing with it lucrative opportunities for purchasers, sellers, landlords and tenants of commercial property. Along with these opportunities come various issues that any sophisticated owner or operator of real property must take into account when evaluating whether to pursue the opportunity considered. Those issues should manifest themselves in the commercial lease or purchase and sale agreement. Some examples of such issues are below.

Institutional Financing

Every owner and tenant seeking to use property for cannabis-related uses should consider whether there is an existing mortgage or deed of trust affecting the property. Since recreational cannabis remains illegal under federal law as of the date of this article, and most loan agreements allow lenders to default the borrower if illegal activities are conducted on the property, there is a risk that the lender will put the borrower in default, foreclose on the property and evict the tenant. This is obviously a significant risk for the owner who may lose his property and the tenant who could lose its leased premises after investing significant sums of money to build the space out for its intended use.

Additionally, a purchaser or owner of real estate who is seeking to lease to a cannabis user and subsequently obtain financing will also have trouble. Most institutional lenders will not grant financing to borrowers who lease space to a recreational cannabis operator due to the continued conflict between state and federal law. Furthermore, even if the borrower can convince the lender to loan the funds, the parties will run into further roadblocks in obtaining title insurance, which is a requirement of all institutional lenders. As such, many borrowers will have to rely on private loans or equity in connection with their property being occupied by a cannabis operator while recreational cannabis remains illegal under federal law.

Title Insurance

As stated above, most national title insurance companies will not insure properties which are used for the cultivation or sale of cannabis due to its status under federal law. In fact, many policies now include a specific exception to the insurance policy which may read as follows:

NOTICE: Please be aware that due to the conflict between federal and state laws concerning the cultivation, distribution, manufacture or sale of marijuana, the Company is not able to close or insure any transaction involving Land that is associated with these activities.

Another matter to consider is who will act as escrow agent in connection with the purchase and sale of a cannabis-related property. Due to the conflict of law issue, many title companies that generally act as escrow agents in connection with the purchase and sale of property are refusing to do so for a cannabis-related transaction.

As such, owners need to consider alternative title insurance options and escrow service options or purchase the property without the benefit of such title insurance.

Insurance

The landlord and tenant should notify their respective insurance carriers of the cannabis use in the building in order to avoid the denial of a claim under either parties' standard insurance policy in the event of a casualty. The insured's premium will likely increase significantly as a result of the cannabis use; however, that added expense is simply the "cost of doing" business in the cannabis space at this time and greatly outweighs the likelihood of the denial of an insurance claim after a casualty event if such use was not disclosed. The allocation of that increased cost should be an economic consideration for both tenants and landlords and addressed in the lease.

Forfeiture

Due to the illegal status of cannabis under federal law, civil and criminal forfeiture remains a risk for both owners and tenants in the cannabis space. It is in the interest of both landlord and tenant to consider early lease termination and atypical indemnification clauses. These provisions should be drafted to consider as many scenarios as possible, including seizure actions against either the landlord or tenant.

Environmental

The cultivation of cannabis implicates many environmental concerns, including those issues arising from the use of fertilizers, pesticides and herbicides at the premises, in addition to the disposal of cannabis products and byproducts which both parties should take into account in their lease or purchase agreement. Landlords and purchasers will want to take the necessary precautions in their agreements to ensure that the property is in compliance with all environmental laws, including remediation laws.

Permits

Any lease or purchase agreement should take into consideration the permits required for the operator to cultivate, manufacture and sell recreational cannabis on the property. In many cases, the permit process requires the operator to have a signed lease in place prior to making the application. As such, any lease and purchase agreement should include contingency language with respect to cannabis-related permits. Additionally, both parties should take into consideration the fact that cannabis-related permits are generally non-transferrable and should address this in the assignment/sublease section of any lease.

Venue

Both parties entering into a cannabis lease should take into consideration that the agreement could be voided for illegality if there is a dispute due to the status of recreational cannabis under federal law. This would leave both parties in a situation where there is no recourse for the action they commenced. It is possible to avoid this situation by including an arbitration clause in the agreement as the required resolution mechanism. Furthermore, selecting arbitration may mitigate the risk of the dispute being removed to federal court.

Utilities

Both property owners and tenants should take into consideration the high volume of electricity and water usage required for cannabis cultivation when negotiating the utility provisions in leases and when evaluating the overall economics of the transaction.

While cannabis remains illegal under federal law, it is imperative for owners and operators in this space to mitigate as many risks as possible. Both parties to a cannabis-related transaction should understand the atypical issues which invariably exist due to a conflation of the relative infancy of the recreational cannabis industry, the ever-evolving regulations and the continued conflict between state and federal law. There is a myriad of pitfalls to consider by both sides, which should be addressed unambiguously in any purchase agreement or lease. As the industry inevitably becomes more settled in the near future, these issues may become industry-standard. However, at this time, any owner or operator should take the time to discuss and consider the issues prior to entering into any property agreement in connection with the cultivation, manufacture or sale of recreational cannabis.

Ryan V. Stearns is a senior associate at Lippes Mathias Wexler Friedman. He focuses his practice in the area of corporate law and commercial real estate, including commercial leasing, sales and acquisitions, project development and financing.