Legalized cannabis: Should professionals still beware?
Conflicting state and federal cannabis laws continue to raise concerns as some courts tackle the matter.
Entrepreneurs and industries of all stripes across the nation are excited about the business and professional opportunities presented by the legalization of marijuana for both medical and recreational purposes at the state level. Currently, 18 states and Washington, D.C., have legalized recreational marijuana in some capacity (though some programs are not yet operational), while 36 states and Washington, D.C., have legalized medical marijuana. Nevertheless, it is critical to remember that marijuana remains illegal under the Controlled Substances Act (CSA) and continues to be listed as a Schedule I drug (in the company of heroin and LSD).
The conflict between state and federal laws regarding marijuana remains a persistent source of confusion, not only for the marijuana industry but also for the professionals upon which the industry relies for everything from legal and accounting support to insurance/risk management and security needs.
As courts continue to navigate their way through this challenging liability landscape, it is important for professional service providers to acknowledge and understand the unique risks posed by engagement with the marijuana industry and understand that while federal illegality may bar certain claims and actions between marijuana market participants, it may not prevent malpractice and other claims arising from professional services performed on behalf of marijuana clients.
How it played out in court
A recent decision issued by the United States District Court of Colorado in Sensoria, LLC v. Kaweske presents an interesting and unique case study in how courts grapple with these issues and, arguably, inconsistently address concerns regarding marijuana illegality when it comes to professional liability claims.
In the case, the plaintiffs asserted direct and derivative claims on behalf of Clover Top Holdings, Inc., a company formed to participate in various aspects of the marijuana and cannabis industry. Sensoria, an investor in Clover Top, alleged that Clover Top’s management falsely solicited investment, mismanaged the business, and took assets for their own benefit.
During prior motion practice, the court dismissed the majority of Sensoria’s claims because Sensoria “failed to explain how relief could be fashioned that would not endorse or require illegal activity or would be paid from an asset source other than marijuana.”
In other words, the claims against Clover Top’s management were dismissed because the growth, distribution and sale of marijuana remain illegal under the CSA, even though recreational marijuana is legal under Colorado state law. In an effort to surmount the illegality issue, in its second amended complaint, Sensoria sought to recast its relationship with Clover Top as that of a “passive investor” whose intention was to invest in a lawful business. In doing so, Sensoria argued that since there were aspects of Clover Top’s business that did not violate the CSA, its investment could have been lawful under the CSA. Sensoria further argued that since Clover Top owns assets such as buildings and land, which are not inherently unlawful, there were assets against which it could collect, which did not violate the CSA.
In dismissing a slew of claims asserted by Sensoria, the court rejected both contentions. First, the court held that while aspects of Clover Top’s business may not have been illegal under federal law, it was clear from the pleading that Sensoria was aware of Clover Top’s involvement in “growing, selling and processing marijuana.” The court further noted that while assets like Clover Top’s buildings and land are not “inherently unlawful,” they were still being used for marijuana and could technically be subject to criminal forfeiture.
In expanding upon the illegality issues, the court wrote: “It is Sensoria’s ownership interest in the marijuana business and the recovery of the benefit of its investment that underlies this lawsuit. The relief it seeks directly concerns the business. However, the court may not vindicate equity in or award profits from a business that grows, processes and sells marijuana.”
Key aspects of this lawsuit concern activities that represent either actual ongoing CSA violations (by defendants) or the attempt to recover the investment in an enterprise (Clover Top Holdings, Inc.) whose activities implicate the CSA. Marijuana is not an indirect or tangential aspect of the dispute. It lies at the heart of the business and thus the lawsuit. Even if Sensoria may litigate its various causes of action, it demonstrates no form of redress that this federal court may provide.
In addition to its claims of mismanagement against Clover Top’s leadership (which largely failed), Sensoria also asserted a derivative legal malpractice claim against Clover Top’s attorneys, the “Tannenbaum defendants.” In doing so, Sensoria alleged that the Tannenbaum defendants “failed to maintain (Clover Top’s) corporate status and assure compliance with governing law to keep (it) a viable entity.”
Sensoria further alleged that the Tannenbaum defendants did not ensure compliance with federal law, which the court presumed to be a reference to the CSA. In denying the Tannenbaum defendants’ motion to dismiss, the court did not undertake the illegality analysis that was conducted when assessing the claims asserted against Clover Top’s owners and managers. In this regard, the court seemed to look past the fact that if Clover Top had remained a “viable entity,” it would have existed for business purposes expressly prohibited by the CSA and derived income from such “illegal activities.” Even though the “illegal” nature of Clover Top’s business prevented Sensoria from pursuing many of its claims against Clover Top directly, the court permitted Sensoria to pursue its malpractice claim against Clover Top’s attorneys.
Interestingly, the court appears to permit Sensoria to pursue a malpractice claim against the Tannenbaum defendants arising from their alleged failure to ensure that Clover Top remained compliant with federal law, i.e., the CSA. This is in stark contrast with the court’s holding that Sensoria was precluded from asserting direct claims against Clover Top due to its participation in the marijuana industry, because at the time of Sensoria’s investment, “there was at least some indication that marijuana would be involved to a substantial degree, even if Sensoria subjectively did not appreciate that fact nor the full range of the legal consequences.”
While portions of Sensoria’s claims against Clover Top’s managers were dismissed based upon illegality considerations and Sensoria’s notice that it was investing in a business, which may violate the CSA, the court did not take those same considerations into account when addressing the Tannenbaum defendants’ motion to dismiss.
As more professional service providers enter the cannabis space, they must be aware of the potential liability risks in doing so. Moreover, while conflicts between state and federal laws may preclude certain contractual and other liabilities arising from the business interactions between market participants, as Sensoria demonstrates, courts may be hesitant to apply such liability hurdles to claims against professionals who service the industry. This potentially makes professional service providers targets for lawsuits, as they may be the only ones against whom certain claims may be brought.
Jonathan Isaacson is partner and co-chair of the cannabis law practice group at Kaufman Dolowich & Voluck LLP in Woodbury, New York.
Adam Nicolazzo is an associate at Kaufman Dolowich & Voluck, LLP in Woodbury, New York, where he focuses his practice on professional liability defense, directors and officers claims, and commercial litigation matters.
Opinions expressed here are the authors’ own.
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