Securing Site Control in Cannabis Licensing

Foley Hoag LLP - Cannabis and the Law
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Foley Hoag LLP - Cannabis and the Law

In most jurisdictions, applicants need to evidence some form of site control of the location for which they are seeking to secure a license to operate a cannabis facility.  While some jurisdictions allow provisional applications that let an applicant apply preliminarily without a location or simply identify a location, eventually every applicant needs to evidence control of the proposed site, either in the form of fee ownership, a lease, an option to purchase or lease, or a letter of intent to purchase or lease.  There is no one best solution or one size fits all approach to this real estate issue, but there are pros and cons to each approach.

Fee ownership offers the most certainty, but it is obviously the most significant investment in terms of cost and time.  Property ownership requires an applicant to perform fundamental due diligence, including zoning, environmental and title reviews, all of which take time and money.  For many applicants, particularly in urban areas and core markets, the up-front cost to acquire a property without the certainty of having an license in place is simply too risky and/or cost prohibitive.

An executed lease provides the next best level of certainty after fee ownership without the burden of the up-front acquisition cost and a lower burden of due diligence.  A properly structured lease can provide an applicant with the certainty that they will have the absolute right to operate their intended use on the site for a minimum term of years at a fixed or known cost, and may include the upfront or pre-negotiated right to perform specific improvements.  Ideally, the lease will include a termination right for the tenant in the event they are unsuccessful in obtaining their cannabis license.  Absent such right, the downside to an executed lease is the tenant is locked into a legal contract to pay and perform with significant consequences if the tenant defaults, including loss of security deposit, rent acceleration, and associated costs and fees.  The strength a lease provides is its flexibility, provided it is negotiated properly.  A cooperative landlord may allow the tenant a reduced rent structure during  the permitting or licensing period with a full rent obligation only commencing upon commencement of operation of the facility.  That same strength of flexibility can become a cumbersome burden in a poorly negotiated lease when there is too much uncertainty.  The dilemma many applicants face is not having the time to enter into a properly negotiated lease, particularly if they are assessing multiple sites.  This leads them to take the option approach.

Options are a trade-off.  They are basically agreements to agree, which are typically frowned upon in contract law, but made binding through consideration.  They are typically shorter in length than the subsequent document that will be executed upon the exercise of the option (the purchase and sale agreement or lease), so they take the least amount of time and up-front cost to negotiate.  However, the shorter and less detailed the option is, the greater the risk to the option holder.  A thoroughly negotiated option to purchase can actually contain the vast majority of essential terms that would be included in a subsequent in a purchase and sale agreement, which creates the least amount of risk to the option holder that the parties will not be able to agree upon a material term at the time the option is exercised (typically after the cannabis permit has been issued when the option holder now has the least amount of leverage).  A short, two page option agreement may be sufficient to be legally binding, set a price, and give the purchaser exclusivity, but the more material terms that need to then be negotiated greatly diminishes the buyer’s leverage, which can subject the buyer to re-trades on price if the parties can’t some to a mutually agreeable purchase document (which is a typical contingency to the successful exercise of an option).

Options to lease are somewhat of a misnomer and are really in their simplest form just a binding letter of intent or, in their most complex form, something just shy of a full lease with a termination right.  Most letters of intent to lease are explicitly non-binding other than a short period of exclusivity between the parties to negotiate the lease agreement.  A letter of intent to lease can be made binding, provided there is consideration in the form of some type of option payment, and it can provide for exclusivity to the option holder.  However, it creates the greatest amount of risk to the option holder, particularly the longer the option period is.  While a valid and legally binding option to purchase may allow a purchaser to pursue specific performance in the event of a seller default, such a remedy becomes a lot more uncertain to the holder of an option to lease or letter of intent where material terms have not been agreed to and damages become speculative.  While an LOI or lease option may be sufficient to satisfy cannabis regulators in the application process, the risk to the applicant that they will be able to negotiate a fair lease after a permit has been issued diminishes significantly once the license is tied to the location.

At the end of the day, the best position an applicant can be in at the time of submitting an application is to have a binding document in place for site control of the property that contains as many material terms as possible, is contingent upon successfully obtaining the applicable cannabis license (or otherwise contains a termination right for failure to obtain), and is in a form that is generally recognized by courts, common law and contract law in the jurisdiction in which the property is located.  Fully negotiated purchase and sale agreements and leases top this list, followed by binding options to purchase.  Binding letters of intent provide the greatest uncertainty, and therefore the greatest risk.

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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