Legalization of Hemp Will Give Businesses More Recourse and Certainty in Court

Harris Beach PLLC

The 2018 Farm Bill, once signed into law, is expected to have a liberating effect on hemp and hemp-related businesses. Some of the impacts of this legislation are clear, such as opening the industry to new entrants and making CBD products more widely available. Other positive ramifications may be less apparent, but still critically important to individuals working hard to make their businesses profitable and build strong commercial relationships.

For example, as is the case with many companies, hemp-related businesses face the possibility a given transaction may not pan out. A customer could refuse to pay a grower or processor for services performed. Weather events might diminish crop output. A landlord who leases commercial space to a start-up hemp-business tenant might lose out on rent if the tenant fails to become operational.

Normally, in these circumstances, a business can consider filing a lawsuit to recover money damages for breach of contract. Or there may be an insurance policy that protects against a loss, and a claim can be made with the insurance company. These and other remedies typically exist for businesses involved in problematic commercial transactions.

Prior to the Farm Bill, however, it was questionable whether such remedies applied to businesses involved with hemp. Because much of the hemp plant was treated as a controlled substance, these businesses were ostensibly involved in an unlawful trade. While they could file a lawsuit seeking money damages or take other remedial action, they had to tread carefully in light of the “illegality” defense.

Prior Cases That Raised the Illegality Defense

The Illegality Doctrine generally prevents a claimant from prevailing when the claimant, itself, does not have “clean hands” on account of its engagement in an illegal business – for instance, prior to passage of the Farm Bill, the unlawful cultivation and sale of hemp.1

Over the years, many courts dismissed cases that raised an illegality defense, leaving the claimant with nothing. Just this year, for example, a private lender sued a cannabis business for failing to satisfy a multi-million dollar loan agreement.2   The cannabis business attempted to justify its refusal to repay the money by – ironically – raising the illegality defense, claiming its own unlawful possession and cultivation of cannabis rendered the loan unenforceable (Id.). The U.S. District Court for the District of Nevada, which heard the case, agreed with this argument, observed the lender knew its borrower was engaged in an unlawful business, and struck down part of the loan agreement (Id).  The court declined to enforce those portions of the loan agreement that would have required the borrower to continue that unlawful business (for example, using a portion of the borrowed funds as operating capital) (Id)

Another matter is instructive in those simpler cases where a purchaser fails to pay for goods or services. A grower commenced a breach of contract lawsuit against a purchaser who, despite accepting delivery, failed to pay a $40,000 purchase order.3 In reading the written decision, one may initially feel optimistic, since the court observed “that a contract exists and that Defendants have failed to perform under that contract ….”   Id.  However, the court’s reasoning did not end there; it recognized the state (at the time) and federal prohibition against the cultivation and sale of cannabis. Id.   The court therefore held the contract was against public policy and unenforceable. Id.

In a case involving insurance, after plants were stolen, a grower – who was operating in compliance with state law – filed an insurance claim to cover its losses.4   The insurance company denied the claim and a court upheld that determination, stating the insurance policy could not be enforced because, while in compliance with state law, the claimant’s business ran afoul of the federal government’s treatment of cannabis as a controlled substance. Id.

The Farm Bill Should Make Recovering Losses More Certain

Positively, due to the Farm Bill, decisions relying on the illegality defense should become rare, or maybe even extinct (provided the parties to litigation are not running afoul of agency regulations). This should lend certainty to hemp-related business using the court system to recover losses.  In other words, there will be much more freedom to contract with suppliers, vendors, consultants, customers, etc., as well as to enforce breaches of those contracts.

The opportunity will be presented to instill meaningful terms in contracts and expect them to be upheld on a case-by-case basis. For example, exclusive venue provisions can prevent a business from being sued outside of the county or state where it is located (on another party’s home turf).  Arbitration clauses and jury waivers can substantially reduce the time and cost of resolving a dispute, as compared to the court system.  Indemnification and additional insured provisions should be seen as incredibly important and used frequently, since these provisions are designed to absorb the costs of litigation and settlement where a business is sued but the party it entered into the contract with is really at fault.

Moreover, given the possibility the Farm Bill will result in a great many new businesses entering the industry, established businesses should consider fallback measures when contracting with start-ups that may be incapable of meeting their payment obligations. These measures might include requiring an early retainer; obtaining alien against real estate, furniture, fixtures, or equipment belonging to other party to the written agreement; entering into personal guarantees with the start-up’s principals or investors who, personally, may have access to cash; and/or requiring the start-up to pay for an insurance policy.  These types of creative contractual terms and conditions can be expected to receive favorable treatment by the courts once the President signs the Farm Bill.

Of course, it is always best to consult with your company’s in-house attorney or outside general counsel to prepare the best contract possible. An optimal contract should implement protections in case of potential future loss.  Importantly, it should also be bilateral and favorable enough for both parties so they will want to continue doing business together for years to come.

1. See N.Y. C.P.L.R. § 3018(b); Carcione v. Rizzo, 154 Misc. 2d 13, 16 (App. Term 1992).

2. Bart St. III v. ACC Enterprises, LLC, No. 2:17-CV-00083, 2018 WL 4682318, at *1 (D. Nev. Sept. 27, 2018).

3. Haeberle v. Lowden, No. 2011-CV-709, 2012 WL 7149098, at *1 (Colo Dist. Ct. Aug. 8, 2012).

4. Tracy v. USAA Casualty Ins. Co., 2012 WL 928186, at *1 (D. Haw. March 16, 2012).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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