Alaska’s first retail marijuana store opened its doors in the fall of 2016. Since then, a few hundred Alaskan businesses have formed to support the industry, and the marijuana legalization movement is expanding nationwide. Currently, 11 states and the District of Columbia have legalized marijuana for general adult use, and a total of 33 states and D.C. have broad medical marijuana programs.
Despite these state-level changes, federal law continues to prohibit the use, possession, or sale of marijuana—a jurisdictional conflict that remains problematic for marijuana businesses. Businesses face challenges along a spectrum of minor inconveniences, such as being unable to alter a facility’s physical layout without regulatory approval, to major frustrations like unfavorable federal tax rules. Some of these challenges are downright dangerous and present public safety concerns, like lack of access to banking services, thereby forcing businesses to manage, store, and move large quantities of cash on and off site.
Indeed, despite an increasing market size and growing mainstream acceptance, marijuana businesses still cannot run like normal businesses; everything they do is a little harder and more complicated. This is true even in the realm of private agreements, where typical contract law proves insufficient. For example, and as discussed below, there are unique lease agreement considerations for all licensed marijuana establishments.
Leases play a critical role in marijuana licensing. Having exclusive legal access to the property where the facility is located is a precursor to licensure and a key component of the state’s regulatory framework. Unlike the alcohol industry, where licenses can be transferred from one operating location to another, marijuana establishment licenses are tied to a specific location. Therefore, if a licensee loses the right of possession, the business will be unable to operate, and the license itself will be jeopardized. Because a lease is such a critical part of a successful marijuana business in Alaska, it is important to understand the characteristics of this industry and pay close attention to them when representing clients in a marijuana-related transaction. When entering into a commercial lease for a licensed marijuana establishment—either as a landlord or tenant—there are a number of unique factors to consider.
Current and Exclusive Possession Required
An applicant for a marijuana establishment license in Alaska must prove: (1) access to the proposed licensed premises at the time of application; and (2) possession of the premises with each annual license renewal application—an ongoing requirement. Thus, it is important to ensure that leases do not lapse, and that the extension and renewal terms or options are clear and exercised as necessary.
A marijuana establishment must also demonstrate the right to possession of the entirety of the licensed premises—no portion of it may be subleased to another party for any reason. Accordingly, no one else can occupy the space and/or be paying rent at the time of license application. This can create unanticipated problems due to the length of the licensing process. In addition to Alaska’s typical weather-related or fishing season and construction delays, it takes a minimum of several months for the state’s Marijuana Control Board (MCB) to review the application, and then additional time before local requirements can bet met. Factoring time for buildout, permitting, and licensing, some licensees can expect to pay rent for almost a year before actually opening for business.
This is obviously a significant expense for a new business, and few can afford to absorb it. But without the ability to sublease while a license application is pending, that’s what marijuana businesses must do. Both landlord and tenant must understand that a gap between signing a lease and beginning operations is inevitable and can factor that into the rent—either through a pre-licensure grace period or with rental payments that escalate over time. “Lost” rental income during this early stage can be ameliorated by requiring a longer lease term, amortizing the “lost” year into the rent payments due following licensing, or negotiating rent that includes payment of a percentage of business revenue.
Clearly Establish and Explain Permitted Uses
The MCB will review the lease as part of each licensee’s application, and will look there for acknowledgement that the property can be used for marijuana establishment purposes. The lease must also clearly establish the type of marijuana establishment activity that will be permitted on the property (e.g., cultivation, product manufacturing, retail sales, or testing). Landlords may also want to require that the permitted use is conditioned upon the tenant remaining in compliance with all applicable laws and regulations.
Marijuana laws and regulations are constantly shifting, so leases may need to be revised, and other related regulatory filings may be required to maintain compliance. For instance, some local jurisdictions will require a supplemental statement from the landlord acknowledging that there will be a marijuana facility on the premises, many months after the lease is drafted. Landlords may also be asked to appear at local community council or planning commission meetings.
Landlords should understand their potential involvement in the licensing process and agree to not unreasonably withhold such assistance. Writing a clause into the lease acknowledging the ever-shifting legal framework can help avoid problems down the road. For example, a clause that provides, “The parties agree to make any amendments to the lease that are reasonably necessary to avoid failing to satisfy the requirements of local, state, or federal guidelines regarding marijuana enforcement, as those laws, regulations, and guidelines may be amended from time to time,” can protect the interests of both parties.
Limited Access to the Premises
A standard lease gives landlords the right to access the property at any time with reasonable notice in order to conduct inspections, perform maintenance/upkeep, and make any needed repairs. Toward the end of a lease term, landlords will require access to show the property to prospective tenants. However, if the leased property is a licensed marijuana establishment, marijuana regulations impact a landlord’s right of access, and both landlord and tenant must agree to comply with certain access conditions in order to successfully obtain a license.
Specifically, the landlord must acknowledge that they cannot enter or remain on the property unescorted, and that a tenant representative must serve as an escort during any entry; the landlord must agree to comply with the tenant’s established and approved visitor policies whenever accessing the premises; and if the landlord must enter the premises and the tenant cannot be reached or does not provide access, the landlord will agree to first contact the State of Alaska Alcohol and Marijuana Control Office (AMCO), or other relevant government authority, prior to accessing the premises. Similarly, in the event of the tenant’s default, the landlord must first contact AMCO prior to any re-entry or re-possession of the premises.
Restricted ability to take possession of property
Because only licensed marijuana establishments are authorized to possess regulated marijuana and marijuana products, the landlord may not take possession of or remove such property to satisfy any outstanding debts. Similarly, if a tenant abandons the property, or if there is any other event that would otherwise permit the landlord to re-possess the premises, or to enter the premises and remove personal property, the landlord must first contact AMCO for guidance and assistance.
The lease should be drafted to include a disclaimer that acknowledges these regulations, and landlords should be aware from the outset that taking possession of marijuana inventory will not be security against a breaching tenant.
While a graduated or percentage rent agreement can be appealing, regulatory considerations extend beyond standard economic questions. The Alaska marijuana regulations are unclear on this topic, providing only that “rental charges on a graduated or percentage-lease rent agreement for real estate leased to a licensee” are not prohibited. This gives landlords and tenants latitude to negotiate a percentage of profits payment in addition to base rent, but regulators will closely scrutinize any lease that appears to use a percent rent payment as a way to circumvent other licensing or ownership requirements. Landlords and tenants should err on the side of reasonableness and negotiate a percent-rent rate that will pass regulatory muster.
If a landlord’s property is financed, a marijuana establishment on the property could jeopardize the landlord’s mortgage. Traditional lenders (i.e., banks) are conservative by nature, and most will not risk association with marijuana businesses. These lenders abide federal law. As far as most mortgagors are concerned, because marijuana is illegal under federal law, it is illegal. Full stop.
Mortgage loan agreements almost always provide for “compliance with all laws,” and make non-compliance grounds for default. Thus, renting mortgaged property to a marijuana business that operates outside federal law could violate the loan agreement. In that case, lenders have various rights and remedies, including declaring a default and calling a loan due in full, or commencing foreclosure proceedings. Some lenders might provide an opportunity to cure by allowing time for the offending tenant’s eviction. That is far from an ideal solution: it leaves the landlord without a tenant and the tenant without a place to operate its business and will likely lead to a messy dispute.
Landlords should know that their lenders could hold them in breach and consider that risk before renting to a marijuana establishment. To protect themselves, landlords may want to include a lease term that allows early termination without penalty in the event of a threatened mortgage default. Of course, that is risky for a tenant, whose business would always operate under a cloud of uncertainty.
Tenants likewise should seek to protect themselves. In the best-case scenario, a marijuana tenant would only lease property owned outright by the landlord or is otherwise not subject to a loan agreement with such compliance requirements. However, with commercial property suitable for marijuana businesses in short supply, that is not always an option. Tenants should therefore similarly be aware of the possibility of these mortgage-related risks and determine the status of a property’s financing before signing a lease. If the property is mortgaged, tenants could try to negotiate a lower rent price that accounts for this risk and seek terms that would otherwise minimize their damages. Tenants could also work with the landlord to provide alternative means for refinancing without a traditional lender.
Exclusion of the Federal CSA from “Unlawful Purpose” or “Illegal Use”
Finally, as with any marijuana-related contract, a lease agreement must address the federal-state law conflict. Standard lease agreements typically contain a term providing that the tenant shall comply with all laws, shall not use the property for any unlawful purpose, or that illegal activity is prohibited, and that failure to comply constitutes a breach. Such a broad clause could arguably allow a landlord to evict a marijuana establishment tenant at any time, because marijuana remains illegal under the federal Controlled Substances Act (CSA). It would probably be difficult for a landlord to evict solely on these grounds in a state where commercial marijuana activity is legal and where the lease expressly allows such a use, but this issue could be avoided entirely if the landlord and tenant stipulate that any unlawful purpose or illegal use excludes violation of the marijuana-related sections of the CSA.
Commercial marijuana landlord-tenant relationships can be difficult to navigate and are ripe with potential problems due to strict regulations and a continually shifting legal framework. Every lease will vary depending on the interests of the parties, the location of the property, and the type of activity contemplated. Consequently, marijuana industry leases should be given expert care and attention. If you are a landlord or tenant considering entering into a marijuana industry lease, feel free to contact Birch Horton Bittner & Cherot to set up a consultation.
Note: a version of this article appears in the September 2019 edition of The Alaska Bar Rag