Business Litigation in the Cannabis Industry | KHS Cannabis Series: Part 1

PART I: If Cannabis is Federally Illegal, How Can I Enforce Agreements in the Cannabis Industry?

Prior to California legalizing medical and adult-use cannabis, many cannabis operators ran their businesses on handshake deals. Businesses formed and agreements were made under the sheen of the black market, and when disputes arose, one key defense depending on what side you are on, would be to claim the agreement was related to cannabis, which is federally illegal, thereby invalidating the contract because it pertains to an unlawful activity.

However, with the passage of AB 1159 in California, cannabis related contracts are now enforceable if they are otherwise compliant with state law. With this landmark bill, capturing agreements in writing will become essential to help protect businesses from lawsuits over misunderstandings that can occur due to the limitations of oral contracts. Operating agreements, bylaws, and shareholder agreements exist to ensure that a company’s structure and the relationship between its owners is crystal clear. Oral agreements have many downsides that make taking advantage of AB 1159 for cannabis related contracts beneficial for partnerships, but translating oral agreements to written form has its own obstacles.

Oral agreements are generally valid and enforceable under California law, but there are important exceptions. Verbal agreements that are illegal in nature or violate federal, state, or local law are void and unenforceable. For instance, an oral agreement to sell or purchase a stolen car would be invalid. In the context of partnerships related to cannabis, oral agreements prior to the passing of AB 1159 may be considered unenforceable because they were illegal at the time of creation. AB 1159 is less than a year old, and cases that will test the sufficiency of oral contracts made prior to the AB 1159 are only now being brought.

Another potential problem in maintaining a partnership through an oral agreement is pursuant to California Civil Code §1624, referred to as the Statute of Frauds, which requires certain contracts to be in writing. This includes agreements that are not to be fully performed within a year of their creation. As most partnership agreements are intended to survive the course of a year, the Statute of Frauds may be invoked in litigation and the court may choose not to enforce the contract as a result.

Even assuming a court can enforce an oral agreement, without some sort of written instrument memorializing the agreement, the specific rights and obligations of the parties will often boil down to he-said-she-said. Any attempt to solve the dispute internally will likely go nowhere and pursuing litigation to enforce one’s rights will be costly and possibly just as fruitless. The best way to avoid these kinds of problems is to memorialize the contract in writing.

Besides simply avoiding the pitfalls of oral agreements, there are significant advantages, like clarity and stability, in having a written contract.  Written contracts are attractive to vendors and give investors confidence to invest in such ventures. Unfortunately, there are sure to be disputes when converting the terms of handshake agreements to ink on paper.

Agreements that have lasted for years may suddenly breakdown when the particulars need to be expressed in writing. Not only may partners disagree on what the understanding was at the time of the handshake, but it is also likely that other factors have changed that may make the original agreement seem unfair to one party or another. The aggrieved partner may want to push for a drastic departure from the oral agreement that was not planned when it was originally made.

Some might want to avoid the hassle of rocking the boat of a working partnership with the long and potentially contentious process of hashing out the details in writing. This is a mistake. Even an honest partner may truly remember an agreement differently than the other. It is far better to discover the discrepancies in the understanding of any agreements early on to reduce the costs of resolving as much as possible. After all, an ounce of prevention is worth a pound of cure

Furthermore, without a written agreement, owners in a partnership will be forced to abide by the state’s default rules with regard to the business structure. The Uniform Partnership Act, the General Corporation Law, and the Revised Uniform Limited Liability Company Act control for the respective entity type absent a written agreement. While these default rules may work for some, more than likely a unique business arrangement will not fit neatly within the legislature’s general framework, and one or more of the owners may bear the full brunt of the disparity.

Despite these shortcomings, translating oral agreements into written form will likely save any partnership headaches, cash, and even relationships in the long run and should be a top priority.

KHS assists clients in many aspects of the cannabis industry including products liability, intellectual property and business disputes as well as business formations including partner and investor agreements, licensing and intellectual property protection. The firm also provides comprehensive litigation services ranging from breach of contract, trademark and trade secret infringement, unfair business practices and more. To make sure you are protected, contact KHS today.

Cannabis Industry Business Litigation