Obtaining retail space for any small business is a big move. There are many issues to consider, and working with a knowledgeable real estate lawyer helps to avoid surprises down the road. This is especially true for a cannabis business for two principal reasons. First, cannabis businesses are highly regulated at the state and local level. Second, cannabis generally remains illegal at the federal level. A standard retail space lease is just not going to suffice. So, the question is, what does a cannabis business need to do and watch for when obtaining a retail space?
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Douglas Charnas: Welcome to our first podcast in a two-podcast series on retail space for your cannabis business. I'm Douglas Charnas, a member of McGlinchey's Washington, DC office. I practice corporate and tax law. I'm joined today by my colleagues, Perry Salzhauer and David Waxman.
Perry is located in McGlinchey's, Seattle, Washington office. He represents clients on a broad range of corporate and environmental matters. His years of working on business processes, SEC, and environmental compliance make Perry uniquely qualified in the emerging cannabis space, where navigating complex compliance and regulatory implementation is a major barrier to entry and ultimate success.
David is located in McGlinchey's Cleveland, Ohio office. He represents clients on matters pertaining to real estate acquisition, development, redevelopment, construction contracts and transactions, environmental compliance and insurance, finance, opportunity zone transactions, leasing and business acquisitions, and divestitures.
So, let's say I'm the owner of a startup retail cannabis business who is looking for new retail space. I have not yet obtained the required cannabis license. In fact, to obtain the license, I need to demonstrate that I have secured retail space. I have spoken to landlords at several retail locations. Each has raised issues in connection with renting space. I've never been a landlord, so I'm not sensitive to the issues from their perspective. Understanding why landlords want certain provisions in their leases will help me with my negotiations. My problem is I'm not sure where to start.
Perry Salzhauer: Well, Doug, you really hit the nail on the head there because most cannabis licensing authorities will require you to show that you have at least secured some right to use the retail space for your cannabis dispensary. Now, how you show you have secured that space will really depend on the licensing authority in your specific state and possibly even your city or town. Let's take a look at a few examples because the different nomenclature used by the different states can really impact what you need for licensure, at the licensure point.
Oregon, for example, requires applicants to provide proof of the right to occupy the premises proposed for licensure prior to issuing a cannabis license. And then, once the license is issued, you're required to maintain control over or have the right of access to all parts of a licensed premises.
Washington State takes a little more heavy-handed approach, in my opinion. They require each applicant to have a leasehold interest in order to obtain a license, and they have to provide the lease or sublease documents at licensure and maintain the leasehold right, or be at risk, as I'll discuss later, of facing a license termination. If the licensee loses the leasehold interest in Washington, the regulators may allow you to change location, but it's discretionary, and in most cases, they'll require you to stay within the same county or city.
Michigan, on the other hand, is a little looser with its application requirements. They require simply that an applicant provide a proposed location for the business, but it has a fairly robust set of pre-licensure requirements that effectively require you to have at least access to the premises.
New York and New Jersey take very different approaches, but they vary for different types of license applicants. Both New York and New Jersey have a provisional application approval process that allows applicants to be approved for a location without having final lease documentation, but they require the documents to be provided prior to the license issuance. New Jersey gives you 120 days following your provisional approval to quote, "establish control of the proposed site through lease purchase or other means." New York requires an applicant to provide the documents that demonstrate the applicant possesses or has the right to use the premises as specified in the application.
As I noted earlier, the provisional process is, for the most part, available only to certain kinds of applicants, and other applicants are required to demonstrate control over the premises at the time of application. Both New York and New Jersey have a continuing requirement to maintain access and control over the licensed premises, but that's effectuated through other rules, including the renewal process.
Now, one final wrinkle to add here is that in virtually every state, cannabis regulators require some form of local sign-off for the premises before the license will first be issued.
David Waxman: Perry, you know that's right. Securing the space isn't the only key to obtaining the license. You're going to have to maintain your right to occupy the space in order to keep your license.
Perry Salzhauer: That's right, David. We recently handled the litigation here in our Washington office that was run by the co-chair my group, of our cannabis group, Heidi Urness. This was involving a client that was licensed in 2016, and as I noted earlier, like most states, Washington requires licensees to maintain its premises and all of the rules surrounding premises maintenance, such as security access, et cetera. This licensee moved the location of the dispensary without getting formal approval.
Now, we argued they had a very good reason for it, but this just highlights the somewhat draconian approach that the regulators take to this access requirement. The LCB, which is the Washington regulator, sought full forfeiture of the license without any warning, skipping a very important administrative step. Heidi prevailed in this case because the court agreed with her that the LCB is required to provide a statement of intent prior to suspending or terminating a license.
Now, the important thing to note here is that our client had a lease for the premises that it occupied and did not ever operate a dispensary there, but the regulator sought forfeiture of the license simply because the client did not, "properly notify LCB of the location change or install cameras even for a dispensary that was not operating."
From a forward-looking perspective, what I take away from this case, and Dave and Doug will talk about it more later, is it highlights how terrible it can be for a licensee if the landlord is able to use self-help or similar remedies to lock a licensee out of their premises. Because if they don't have access, they could risk total forfeiture and lose their business. So, from my perspective, I usually represent clients on the front end.
So, when I represent a cannabis licensee, I try my hardest, I don't always succeed, but we try to make sure there are legal procedures in place before a landlord can exclude or lock out a tenant from a premises. In my experience, an understanding landlord who knows the rules will not fight this so hard, and there's usually a way to come to a mutual agreement on this.
Douglas Charnas: Well, I've always thought that a retail business would lease space from a landlord. This is why I was surprised when the first landlord I spoke with wanted to use a license rather than a lease. I think of a license as something you use for intangible property, but the landlord said more and more landlords are turning to a license. I'm not sure that's true, but if it is, why would a landlord want to use a license rather than a lease?
David Waxman: You know, the use of a license for retail space isn't unheard of, but it isn't common practice. Why would a property owner require a license rather than a lease? Well, generally speaking, even aside from the cannabis operator, the simple answer is that the owner-licensor can just terminate a license at will. In other words, it doesn't have to have a reason; you're out because I woke up on the wrong side of the bed this morning.
So, on the other side, under a lease, tenants are going to have certain protections that licensees under a license simply don't get. A lease is going to provide a tenant with a property interest to the estate in land, and because of that, a landlord typically can't just decide to kick a tenant out for no reason. And in most leases, especially commercial leases, there are going to be sophisticated provisions that deal with these issues. And so, what it comes down to is generally, there's going to have to be a tenant default in order for the tenant to lose possession of the space.
Douglas Charnas: Well, David, before we discuss the merits of a license or lack thereof, I wanted to ask Perry if a license would be sufficient to show a cannabis authority that I've secured a retail space.
Perry Salzhauer: That's a very important point, Doug, because, like I said earlier, it's going to depend on the specific language in the particular state where the licensee is. For example, a state like Washington requires a leasehold interest. In my view, although some of our litigators disagree, Washington would not accept a license because a license does not necessarily represent a quote, "leasehold interest." Now, other states like New York, New Jersey, or Oregon, which use a right to use or right to occupy language, they probably would accept the license.
Douglas Charnas: So, it sounds like in some jurisdictions, a license might work, but is it a good idea? David, I understand why the landlord might opt for a license if it can evict or terminate the licensee from the retail space at will. I know there may be some specific reasons why a license presents issues for the cannabis business, possibly both for the landlord and the tenant, but generally speaking, David, can a landlord simply relabel a lease as a license and benefit from the ability to evict the licensee at will?
David Waxman: Well, you know, and especially from our law school classes, it's not that simple, but the substance is really what's going to control and not what label you're putting on the document.
Douglas Charnas: So, if that's the case, then what are the factors that distinguish a lease from a license?
David Waxman: In general terms, a lease is a contract between a tenant and a landlord. It provides the tenant with an exclusive interest in the property. Now, on the other hand, a license is when the owner gives bare possession to a licensee to conduct an action on the owner's property. So, let's look at some factors here. In a lease, a tenant has basically four things.
One is exclusive use. Two, exclusive use of a particular piece of property, typically a unit in a building, for a specific period of time, in exchange, of course, for payment or rent. Now, the factors that make an agreement a license focus on the rights retained by the licensor as opposed to what you have with a lease. A license agreement has to include a clause allowing the licensor to revoke the agreement at will, as we mentioned earlier. Number two is the retention by the licensor of absolute control over the premises.
And third, the licensor supplying to the licensee all of the essential services required for that licensee's permitted use of the premises. So let me provide a little bit more substance to that. A lease represents a thing of value, and what I mean by that is that because it represents a property right, without restrictions in a lease, it can be assigned and subleased. Whereas on the other hand, a license isn't a property right. It typically gives you or the licensee, more properly, a temporary or a limited time of possession. It does not convey any interest in the property, so it can't be transferred as opposed to a lease which may only be terminated upon a default of the tenant. A license is terminable, again, at the will of the licensor.
Now, the problem in many of these cases is trying to distinguish a lease from a license; it's not always clear, and it isn't going to be cut and dried.
The factors that courts have applied aren't always definitive, and they're certainly, because of that, not absolute. For example, many leases will allow a landlord to enter a rented space to conduct an inspection. For example, leases give the tenant exclusive possession subject to a restriction, with the degree of the restriction dependent upon additional provisions, such as having the landlord provide notice that they can only come in at certain times of the day and may have to be accompanied by the tenant. Also, limitations on frequency. You may be able to do that maybe three times in a lease year.
There's a lot more control that the tenant has, as opposed to the landlord, because the landlord has conveyed a property interest in that space or the property to the tenant. Now, to the degree the factors are either entirely absent or definitely present, the determination of whether a particular arrangement is a lease or license can be pretty straightforward or not.
So, to give some real-world examples here, let's look at a couple of situations where it's not so easy to determine a lease from a license. Let's take a storage space, for example, where a court was required to classify three types of storage that were provided by a marina. The first agreement provided that transient customers could pay a per foot, per day charge in exchange for being allowed to use a boat slip along with certain services, but for a short time, usually one or two days.
And in the second type of agreement, the marina offered winter storage, providing storage, security, minor maintenance, et cetera, in exchange for a fee based on the size of the boat. So, that agreement gave the marina sole discretion as to where the boats were stored, allowing them to be moved and maneuvered at any time, even to a place other than the marina.
Finally, the last agreement provided that customers could enter into a slip rental service and membership agreement for a certain period, in this case, between May 1st and October 31st. The agreement identified the particular slip rented with the cost based on the size of the slip rented and provided that the slip would be available for occupancy at any time requested. So, in this case, the court had different rulings depending upon the substance of those agreements. Now, they found that of those three agreements, only the third agreement was a lease.
And they based that decision on these things: first, there was a six-month period, which was longer than one or two days or a couple of weeks; second, the fact that the customer was renting a specific assigned slip; third, the cost was based on the characteristics of the space reserved rather than the size of the boat; and finally, only that agreement, that third agreement, used the term rental.
And once again, terms are not in and of themselves controlling, but in this case, when you put it in the mix, it had a significant effect on this.
So, in the first example, the space provided to transient users did not have any of these factors that are commonly associated with leases. Now, as for the second agreement, which was the winter storage plan, the court noted that what is provided is storage rather than a right to occupy a particular space.
Now, let's look at another example that involved a case related to a self-service storage unit. In that case, the court found the agreement was a lease as opposed to a license. Now, the main factors the court focused on were number one: customers were required to secure those storage spaces with their own locks. Second, they had exclusive access to their spaces, and the agreement used lease language that specifically identified the storage space by number, required payment of periodic rent, and contained a provision governing notice of termination.
Now here, the degree of control was an important factor. Finally, in a case of poor draftsmanship and ignorance of the law, you couldn't get a better compliment of things. There was a recent California case, and in that case, the parties entered into what they termed as a license agreement. And under that agreement, the licensor granted the licensee the exclusive but nonpossessory right for the use of the property, with the exception of a stage area and a storage building. Now, a section of the agreement provided that it wasn't a lease or any other interest in real estate.
Rather, what it did do was provide that it was a contractual agreement creating a revocable license and that the licensor retained legal possession and controlled the premises, as well as the areas assigned to the licensee. Also, that the licensor had the right to terminate the agreement upon a licensee default.
And when the agreement was terminated, the license to use the premises was revoked. It's clear enough that that agreement was a license rather than a lease. However, and here's where the poor draftsmanship comes in: not knowing the law in your jurisdiction, in an apparent attempt to make it really clear the agreement wasn't a lease, the licensor added language stating that the agreement would be covered by the contract laws and not by the landlord-tenant laws.
While that may appear logical on its face, the court held that by using that language, the parties waived the right to proceed under California's unlawful detainer statute. In some states, that's referred to, as in Ohio, as a forcible entry and detainer statute. An unlawful detainer or forcible entry and detainer statute is a summary proceeding, in other words, a quick process for someone with a present right to possession of property to regain possession over someone holding it unlawfully.
It's typically seven to 14 days from the time you file, at least in Ohio, where you have a hearing on possession. You don't have to go through the entire process of filing a complaint, waiting 30 days for an answer, et cetera, all the stuff you would find in anything other than a real estate unlawful detainer action. Now, in this case, the court held that California's unlawful detainer statute applied only to a landlord-tenant relationship and not a licensor-licensee relationship. And so, even if the parties hadn't declared their intent not to apply California's landlord-tenant laws, the unlawful detainer statute did not apply anyway.
So, to regain possession of the premises, the licensor would've had to go through the process of a normal lawsuit.
Again, where the defendant, in this case, the licensee, would've had a period to answer the complaint, once again in most cases, 30 days, and then go through a lengthier process.
What I would like to note, though, is while California may apply unlawful detainer only to landlord-tenant situations, that concept, meaning unlawful detainer or forcible entry detainer statutes, are creatures of state law. Therefore, some states will apply the statute not only to leases but to license agreements as well. Ohio is one of those states that will apply it also to license situations.
So, I guess in a long-winded sort of way, the point I'm trying to make here is that you really need to make sure you know exactly what you're attempting to do in these situations. In other words, whether you're trying to establish a license or a lease. Once you do that, be very clear as to what you're doing, draft your documents accordingly, and most importantly, know the law of your state.
Douglas Charnas: It's always unsettling when you learn that you don't know what you don't know. Maybe I should open up an ice cream shop. My big takeaway, though, is that a lease or a license for retail space for a cannabis business is much more complicated than a standard retail space lease. I'm going to need a lawyer to guide me through all of these considerations.
Well, Perry and David, thanks so much for this helpful information. I want to thank our listeners for joining us today and to join us for our second podcast in this two-podcast series. The cannabis team at McGlinchey is ready to assist you with obtaining retail space for your cannabis business, or any other cannabis-related issues that you may have.
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