10 Best Practices for Supply Chain Contracts

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Four attorneys share their top 10 considerations for entering into a written agreement with another cannabis company.

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May 29, 2019

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It takes a village to run your cannabis company.

You may rely on vendors, security and tech companies, and other operators to help your dispensary run optimally and smoothly. And with those various relationships come contracts to ensure both you and the other party are protected in the best- and, of course, worst-case scenarios. But are you sure your contracts are working for you and not against you? Unfortunately, without guidance, they may not be.

To help you navigate the complicated world of contracts, four cannabis industry attorneys offer 10 best practices you should follow when drafting legal agreements.

Habib Bentaleb, founder, Law Office of Habib Bentaleb

The Law Office of Habib Bentaleb is a corporate firm that advises direct operators, service providers and investors in the cannabis industry. Bentaleb points out that while the cannabis plant itself is quite old, the industry is still in its infancy—and that can cause quite a few issues for those wading the waters of legal agreements with others.

“Because everything is still so new, the best practices for the cannabis industry are still very much in development,” Bentaleb says. Here are his top four tips for legal documents.

1. Choose your jurisdiction wisely. Your business might be located in California, but if a vendor you’d like to work with is in Florida, that can present potential problems, Bentaleb says. He recommends that you “make sure your governing law and choice of jurisdiction for dispute resolution is [your state] for transactions in [your state],” whenever possible. Without attention to this detail, “you might be contracting with an entity that was incorporated in another state, and they have included their state of domicile as the jurisdictional venue of choice,” Bentaleb says.

Why is this a problem? Bentaleb explains that “if the state of jurisdiction has yet to legalize any commercial cannabis activities—like Wyoming—or is medical-only—like Delaware—your contract will likely be unenforceable in that state. And I can’t tell you how many times I’ve seen contracts with Delaware, or even worse, Wyoming, as the jurisdiction of choice.”

In California, where Bentaleb operates his practice, it is especially important to review the law to make sure cannabis contracts are recognized as lawful. “California only recently updated its Civil Code to explicitly state that cannabis contracts are lawful,” Bentaleb says.

Lastly, Bentaleb adds, “if your business operates in a state that has legalized some type of commercial cannabis activities but its civil code doesn’t address cannabis contracts, then the next best step is to include a binding arbitration clause,” which is an agreement that requires parties to settle disputes out of court. “[In that case], enforcing an arbitration award will depend on the jurisdiction but it’s definitely the best alternative,” he says.

2. Look out for an indemnity provision. “An indemnity provision is basically a form of insurance where one party agrees to make good on a loss or damage that another party has suffered,” Bentaleb says. Before you sign any contract, Bentaleb recommends that you review it to see if an indemnity provision is included, and if it is, read very carefully to understand exactly the liability you are assuming. “Too many sellers are unaware of the size of the liability they are assuming,” Bentaleb warns.

For example, he says, “if you are a cultivator, have you agreed to indemnify a manufacturer or distributor for their own negligence? That might sound outrageous, but in some jurisdictions—California included—indemnity provisions may establish a duty to hold harmless the other party even if they were actively negligent. Is the indemnity triggered at liability or at loss? In the latter, there must be an actual loss or an out-of-pocket payment.”

As Bentaleb has seen, “too many businesses, not just cannabis businesses, gloss over their indemnity provisions as if they were an iTunes or Spotify user agreement. It is extremely important that you review any indemnity provisions and see how they relate to the types of insurance you carry.” If you don’t, Bentaleb warns, “you ignore them at your own peril.”

Are you sure your contracts are working for you and not against you? Unfortunately, without guidance, they may not be.

3. Beware of boilerplate contracts. When it comes to boilerplate contracts (which use a standardized template), Bentaleb’s advice is simple: “Don’t use them,” he says. Here’s why: “This is a highly regulated industry—originating from an agricultural commodity—that is still federally illegal,” he says. “Boilerplate and recycled contracts are not going to help you. Yes, there may be a random provision here and there from that deal you did a couple of years ago … but realistically, you’re only going to get yourself in trouble.”

Remember, Bentaleb adds: “Each state has its own set of specific regulations, so the contract you used in California might not be applicable in Massachusetts.” As such, he says, it’s very important that the contracts you use are tailored for the state in which you are operating.

“Commercial cannabis contracts are still a relatively new concept,” Bentaleb says, “so it’s really important that, as a cannabis operator, you sit down with your attorney, go over all the things that can potentially go wrong, and then put together a contract that will mitigate those risks while complying with your state’s regulations.”

4. Do your research. Before Bentaleb reviews or drafts an agreement for a client, he asks them, “What do you know about this individual or company?” he says. “I ask this of my non-cannabis business clients, as well, but it’s even more important in the cannabis industry, where there’s little historical data. Due diligence is extremely important, and the earlier you start it, the better.”

To do that due diligence, Bentaleb recommends that you visit an operator’s facilities and talk to other vendors who have worked with that operator in the past. “Knowing as much as you can about the other side will make drafting the legal agreement that much easier,” he says. “Cannabis contracts will vary depending where along the supply chain the parties fall, or whether you’re dealing with a service provider. Contracts can cover everything from intellectual property, delivery terms, and other representations and warranties.”

Omar Figueroa, director, National Cannabis Bar Association, and founder, Law Offices of Omar Figueroa

As the founder of a boutique law firm in California devoted to cannabis law, Omar Figueroa knows a little something about cannabis-related contracts. “I have been practicing cannabis law in California for more than 20 years, and our team … is focused on quality,” he explains.

Figueroa recognizes there are land mines in legal agreements in the cannabis industry. “There is a very heavy, and potentially catastrophic, price for failing to follow the best practices for legal agreements, including needless litigation and even insolvency,” he says.

Here, Figueroa provides three of his top tips for building the best legal agreements.

1. Consider the worst-case scenario. When you know the worst thing that could possibly happen, you can take steps to avoid it. For example, Figueroa says, “foreseeing the possibility that a dispensary will be sued on a strict product liability cause of action, it would be wise for a dispensary [that was] drafting an agreement with other licensed operators to include an indemnification clause requiring the distributor or manufacturer of the product to defend and indemnify the dispensary for any litigation costs and liability.” Figueroa recommends considering worst-case scenarios, then working hand-in-hand with an attorney to address those issues before they happen.

2. Look for arbitration clauses. Figueroa says attorneys have a trick when they read contracts: “Litigators read contracts backward,” he says, so that they can catch arbitration clauses they might otherwise miss. In this case specifically, you will want to suss out any clauses denoting courts or any “with teeth and waivers of federal illegality,” Figueroa says.

To do that, Figueroa says, you will need to pay attention to the choice of venue listed in the contract—the court in which any matter will be litigated in if there is a dispute—and try to spot any clauses that might say “one party cannot later claim the contract is unenforceable because it violates federal law,” or the “loser pays winner’s attorney fees,” Figueroa says.

3. Consider when to sign. Once a legal contract is ready to be signed, carefully consider who puts his or her John Hancock on the dotted line. “Somebody with authority to bind the entity which is a party to the agreement has to sign the document,” explains Figueroa. Consult with your attorney for who that might be before sending a representative to sign a legal agreement.

What’s more, Figueroa advises, “ideally the document will be signed [in front of] a notary public to minimize disputes about the authenticity of the signatures.”

Nicole Howell Neubert and Ariel Clark, co-founders and principals, Clark Neubert LLP

Together, Nicole Howell Neubert and Ariel Clark run the woman-owned cannabis business and regulatory law firm Clark Neubert LLP, which is based in San Francisco and Los Angeles. And they recognize the importance of following best practices in this industry.

According to Clark, “Business owners and investors are best served by understanding legal best practices because the intersection of traditional corporate matters and the new and emerging area of local and state regulatory cannabis laws [are] very new,” especially where they practice in California. She adds, “new issues are still being presented and addressed by contracts every day.” And to combat those issues, “operators need experienced counsel who know the lay of the land today, yesterday and what will come tomorrow,” she says.

Here, Clark and Howell Neubert share advice they say will help cannabis companies follow a few common best practices, and make smart decisions when it comes to their contracts.

“Operators need experienced counsel who know the lay of the land today, yesterday and what will come tomorrow.” Ariel Clark, co-founder and principal of Clark Neubert LLP

1. Account for risk of loss. “When a retailer contracts with a company to purchase a product and there is a purchase order issued, the law allows that product to legally become the property of one or other of the parties before they have actual possession,” Howell Neubert explains. At the same time, the law also asks someone to assume the risk of loss—who is on the hook if something was to happen to the product during transit or at any point before it reaches the retailer.

“Retailers should be sure their contracts account for this,” Howell Neubert advises, and any contract should be drafted so that you know what happens when title and risk of loss occur.

2. Consider your local laws. In California, Proposition 65 requires a specific warning be included on all products that do or may contain “marijuana smoke” and/or “myrcene,” Clark says. What’s more, retailers have to post a similar sign, making those disclosures, in their stores. And that’s something that has to be in your contract. “A contract provision would [need to require that] all products sold to the retailer to be in compliance with Proposition 65,” Clark says, as well as have “adequate products liability coverage. It’s crucial to work with … an insurance coverage attorney to review your policy to be sure it’s not gutted by exclusions,” Clark says.

While you may not live in California, other states may have similar requirements that could be easily missed if you’re not aware of them. Ask your attorney what needs to be included.

3. Don’t shake on anything. Don’t agree on anything until you’ve got it in writing—and had a cannabis-focused attorney look over that contract, Howell Neubert says. “The days of hand-shake deals are over,” she says, adding, don’t “get into business relationships before you have a contract in writing.”

Jillian Kramer is a New York City-based freelance journalist whose work has appeared in the online or print versions of Glamour, Food & Wine, SELF, The Wall Street Journal, and more.