11 Common Legal Pitfalls – and How to Avoid Them

Features - Legal Issues

From understanding complex IRS tax codes to verifying licensed distributors, dispensaries face legal and compliance challenges at every turn.

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June 19, 2018
Jillian Kramer
Cannabis Dispensary illustration

According to several attorneys, it’s not that cannabis dispensary owners are prone to more mistakes than the average retail business owner—but the often murky business of cannabis does lend itself to more pitfalls and confusion, which can easily lead to unnecessary errors.

For starters, “The conflict between federal, state and then sometimes state and local laws can be challenging for a start-up entrepreneur,” says Lance Rogers, partner at Greenspoon Marder law firm, which has locations throughout the country.

Of course, there are many reasons this industry might face more legal pitfalls. Here, according to expert attorneys, are the top 11 mistakes your business could make—and how you can avoid them.

Mistake #1: Not knowing cannabis law.

There are many, ever-changing rules dispensary operators must follow, and understanding them isn’t always easy. But, “operators must take the time to understand the [laws’] scope and meaning, because ‘I didn’t know’ isn’t an excuse that will hold up with regulators or in a court,” warns Ariel Clark, partner at Clark Neubert LLP in California. “Taxes are a great example. Taxation around cannabis is incredibly complex in California, the rates vary city to city, and there are many filing deadlines. We urge clients to get professional support to ensure compliance. It can be the difference between keeping or losing a license.”

Mistake #2: Not knowing other applicable laws.

In addition to knowing cannabis-specific laws, “dispensary owners must also follow a host of non-cannabis laws, codes and regulations, which define everything from labor practices to building codes,” says Nicole Howell Neubert, partner at Clark Neubert LLP. “We’ve seen dispensaries do full remodels—without pulling a license from the city. That kind of mistake is an immediate red flag for inspectors when they arrive.” What’s more, Neubert adds, “it’s also a surefire way to have inspectors scrutinizing every other aspect of your business.” So, study up on what laws apply to you as a business owner—not just a dispensary owner.

Mistake #3: Thinking some compliance with the law is good enough.

Partial compliance with laws that govern cannabis sales is not enough, cautions Rachel Gillette, partner at Greenspoon Marder Law in Denver, Colo. “When your license to operate depends on strict compliance, even substantially complying can leave a business in a very precarious situation,” she says. “One slip-up could mean the loss of your business license, and thus the loss of everything you’ve invested in.” So, follow any applicable laws in full, Gillette advises. It will keep you out of trouble and benefit your dispensary. “Strict compliance with state and local laws is also your business’s best defense against federal interference.”

“Operators must take the time to understand the [laws’] scope and meaning, because ‘I didn’t know’ isn’t an excuse that will hold up with regulators or in a court.” – Ariel Clark, partner, Clark Neubert LLP

Mistake #4: Not understanding local, state and federal tax codes—including IRC § 280E.

Those tax codes mentioned earlier could be the undoing of your dispensary if you don’t understand them—so prepare for a worst-case scenario, Gillette says. “Plan to be audited,” she advises, before adding that “it’s not if you will be audited by a local, state or federal tax authority, but when.”

How could taxes get you into trouble? “A significant deficiency assessment [from your cannabis business] for a previous tax year could cause severe financial distress for a licensed cannabis business,” Gillette says. So, before you open a cannabis business, “you should fully understand how and when to collect and remit sales tax, use tax, excise tax, income tax and business personal property tax,” Gillette says.

On the federal level, you should study up on § 280E. However, be wary of what you read, and make sure you are learning from a reliable source. “There is an abundance of misinformation and bad advice on the internet regarding § 280E,” Gillette warns, “and cannabis business owners should have at least an understanding of the IRS’s position and likely application of § 280E.”

If the business is a flow through—where income is passed “through” to the owners, and the owners are taxed instead of the business—Gillette adds that owners should be paying the company’s estimated tax payments on a quarterly basis, taking into account disallowed tax expenses based on § 280E. “It’s essential for your business to keep good books.”

Mistake #5: Not choosing the right location for your dispensary.

Location is important to the success of any business, yet a dispensary owner can’t simply pick any prime location. When it comes to dispensaries, “your location is all about zoning,” says Rogers. “Most communities consider [dispensary location] to be a sensitive or controversial thing, and they put a lot of thought into where a dispensary can and should be.” As such, there are a lot of rules and regulations about where a dispensary can be located. “I think what's most important for dispensary owners is to, at the outset, know the property zone laws, and whether their business meets any buffer requirements—that their business is not too close to a school or a playground or in some cases, a church.”

Rogers adds, “The way to avoid trouble is to be very familiar with the local licensing ordinance, which will tell you specifically where your type of business can and should go.”

Mistake #6: Providing inadequate training.

“We always tell operators, ‘You're only as good as your weakest link,’” says Clark. “If that weakest link is your employees, then they have a problem.” In other words, it’s important to pass along your knowledge of cannabis and business laws to your employees, as exampled by a recent Colorado Marijuana Enforcement Division (MED) bulletin.

The May 24 notice reminded dispensary owners that suggesting that cannabis products are safe or effective to treat medical conditions is an infraction that could lead to administrative action. The bulletin came as a result of the MED being made aware of reports that some dispensary employees were “allegedly providing information on marijuana use to women reporting pregnancy-related morning sickness.”

“Everyone who works in a dispensary must know and follow the law,” Clark says. “The best operators invest the time and resources into getting employees trained so they don’t make mistakes.”

Mistake #7: Failing to adequately supervise or be aware of what is happening in your business.

As they say, the buck stops with you. “A business owner is ultimately responsible [for] what occurs in the licensed business and the licensed premises,” says Gillette, and unfortunately for dispensary owners, “when an owner fails to adequately supervise employees or become aware of what happens within his [or her] licensed facility, he or she cannot simply rely on the fact they ‘didn’t know.’” If your employee commits a compliance violation, such as “diversion of product,” you could lose your license and your ability to operate, warns Gillette. So, in addition to training, make sure you’re aware of what happens inside your dispensary.

Mistake #8: Working with unlicensed distributors.

At one time, dispensary owners in California, in particular, had the freedom to buy from anyone who had a good or otherwise desirable product, says Neubert. But those days are over, she says. “It’s just not worth the risk to work with an unlicensed distributor,” Neubert cautions. “We urge clients to verify the license of every vendor and partner they work with”—sage advice in any market—and then document the verification you receive. “Once track and trace comes online later this year [in California], dispensary owners will need to demonstrate they’ve been compliant while licensed,” Neubert explains.

“We’ve seen dispensaries do full remodels—without pulling a license from the city. That kind of mistake is an immediate red flag for inspectors when they arrive.” – Nicole Howell Neubert, partner, Clark Neubert LLP

Mistake #9: Not laying out terms clearly with your partner(s).

It may seem like a good idea to begin your dispensary business with someone else, whether it be a partner or an investor. But if you don’t define such partnerships in a clear fashion, it could lead to trouble, cautions Rogers.

“Sometimes—because of personality differences or getting taken advantage of—a business owner can get into a dispute with their partners or investors,” he says, “and it can really interfere with the success of the business.”

To avoid problems with your partnership, Rogers advises that you should “really think through your business plan and really consider who your partners are and will be,” he says. “Make sure that everyone is on the same page, in terms of how much money the business is going to cost [each of] you, what percentage each person owns, who's going to manage the business, and what will happen if you need more money.” Once these details have been hammered out, they should “go into the legal documents for the creation of that business,” Rogers advises.

Mistake #10: Hiring the wrong expert or consultant.

According to Gillette, unqualified experts and consultants are very common in the cannabis industry. “Truly qualified experts are rare indeed,” she says. If you meet with an expert who promises to make magic happen for your dispensary—at a substantial fee—you have probably run into someone who is unqualified, Gillette says. “The lesson here is to vet your expert,” she says. You do that by “asking a lot of questions and getting legitimate references before hiring an expert or consultant,” she says. And whatever you do, never hire an expert or consultant to give you legal advice, Gillette warns. “They have no ethical obligation or training to know the law,” she explains. When you do work with an expert, “make sure [he or she] signs a non-disclosure/confidentiality agreement before being engaged” to protect your IP, she says.

Mistake #11: Working without contracts.

Clark and Gillette agree that many cannabis businesses, including dispensaries, are too lax with business contracts. In fact, “in the past, dispensary owners very often had handshake deals with growers and manufacturers,” Clark says. And while that may have made sense in the past, it won’t work today. “Dispensaries must put formal, on-paper contracts in place with vendors, to ensure accountability, but more importantly, to prove regulatory compliance,” Clark says.

Even if you’re working with friends, get your agreement in writing, Gillette adds. “Just because a person is your ‘bro’ doesn’t mean you shouldn’t document your agreement in a well-written contract,” she says. While contracts cost money to draft, “spending … money now to have a lawyer draft your agreement can save you a lot of money in the long run,” she says. “An ounce of prevention can be a pound of cure.”

Jillian Kramer is a New York City-based freelance journalist.