Virginia is for ‘Cannabis’ Lovers

February 3, 2022 docketcallnewsletter

Virginia is the first southern state to legalize adult-use cannabis. Many expect the move to add hundreds of millions of dollars to the Commonwealth’s economy, create jobs, and reduce racial disparities in law enforcement. Opponents raise the specter of impaired driving, teen use, and other public health concerns. Either way, the move comes with a cobweb of legislation and regulations, of which we have seen only the tiniest fraction. The reality facing business owners looking to enter into this industry is one of almost complete uncertainty. The current legislation was passed on April 7, 2021, but multiple provisions are subject to reenactment by the General Assembly in 2022. Basically, everything we currently “know” about the structure and implementation of the cannabis industry in Virginia, is subject to change. Providing reliable legal advice in these shifting sands promises to be a significant and ongoing challenge. It is also no surprise that the lure of profits in an exciting new market, blended with all this uncertainty, leads to a diverse assortment of people interested in chasing the opportunities. Should you find yourself confronted with clients interested in the cultivation, manufacturing, wholesaling, or retailing of adult-use cannabis, here are some basics to bear in mind.

First and foremost, the Virginia State Bar has released their proposed amendment to Rule 1.2 of the Rules of Professional Conduct. Rule 1.2 (c) (3) would read, “A lawyer shall not counsel a client to engage, or assist a client, in conduct that the lawyer knows is criminal or fraudulent, but a lawyer may counsel or assist a client regarding conduct expressly permitted by state or other applicable law that conflicts with federal law, provided that the lawyer counsels the client about the potential legal consequence of the client’s proposed course of conduct under applicable federal law.” This change reflects similar changes that have been adopted by almost every state bar in states that have legalized adult-use cannabis. It is imperative that this is addressed expressly not just with every client, but with every potential client. It is also imperative that clients know the risks of the business that they are entering.

This is not a “small business friendly” industry in any sense of the phrase. While our General Assembly has attempted to make it so in the current draft of the legislation, there are far more aspects to take into consideration than our own state law. Many cannabis ventures, even initially heavily-capitalized ones, do not make it. For an average “mom-and-pop”, it is nearly impossible. Marijuana is still an illegal substance under the Federal Controlled Substances Act. The federal statute prohibits the production, distribution, sale, use, or possession of marijuana, and provides no exception for medical or other uses that are now authorized by Virginia law. This means that no federally-backed small business loans are available to small businesses starting in this industry. It also means that small businesses are denied federal income tax deductions for ordinary and necessary business expenses, except cost of goods sold, per the infamous IRS Section 280E. Couple the denial of business expense deductions with regulations that require far more business expenses than almost any other industry, and this is not a field that many can afford to play on. In addition, if an owner or an employee of a cannabis business is looking to be approved for a federally-backed mortgage or loan and their only income is from the cannabis business, they most likely will not be approved. Cannabis-related income is considered ineligible for underwriting purposes. The few banks that service this industry, when and where you can find them, charge a hefty premium to cannabis businesses just for the privilege. In the same vein, the Federal stance on cannabis prevents many of the traditional lending tools available to other kinds of businesses. Any plant-touching business must own or lease premises which are not subject to any federally-backed loan from a traditional bank. Large enterprises are obviously not as hampered by these restrictions, and are generally better acquainted with the risks. Yet it will likely be the risks, to entities large and small, that cause clients to seek you out.

In the end, the looming challenges are: (1.) licensure, (2.) risk mitigation, and (3.) compliance. No one knows exactly how to navigate licensure and compliance yet, which in turn affects risk mitigation. The Virginia Cannabis Control Authority was created as the regulatory agency for the recreational Virginia cannabis industry. Governor Northam announced his appointments to its board July 9, 2021. Glenn Youngkin stated on the campaign trail that he will not look to repeal the legislation. Virginia House Republicans have also now unanimously elected Delegate Todd Gilbert to serve as House speaker. Delegate Gilbert has stated that he believes Virginia needs to look to other states for guidance on how to avoid their mistakes and do its best to eliminate the black market. While this seems to be the sentiment from both sides of the aisle, the battle will be over how exactly to accomplish this. Both Oklahoma and California have massive illegal markets, however, California’s developed from over-regulation and over-taxation while Oklahoma’s developed with hardly any regulations and unlimited licenses available.

We now await if, or more likely how, the General Assembly decides to change the current legislation during the reenactment process of 2022. Regulations will then be released and, per the current legislation, applications can be accepted beginning July 1, 2023. JLARC, the joint legislative audit and review commission, has recommended that applications be accepted beginning in January 2023, and to eliminate the loophole that might currently allow hemp processors to pay a $1 million fee to become vertically integrated, among other things. While everything is currently just a waiting game to see what happens with the legislation, moves are being made right now. This is the time to prepare businesses for all they can expect over the next two years, and how to get ahead of the curve. With a great change comes a great opportunity, and our profession is desperately needed to work alongside regulators and legislators in helping Virginia businesses and farmers take advantage of this one.

About the Author

Caroline Gallagher is a Partner at Magee, Goldstein, Lasky, & Sayers. She was born in New Jersey and raised in North Carolina. Ms. Gallagher worked for almost a decade as general counsel for a financial advising firm and has an extensive background in compliance, finance, corporate formation, and business law. Since joining private practice, Ms. Gallagher has been working with businesses entering the cannabis industry here in Virginia. Cannabis is an emerging area of the law in the Commonwealth and involves numerous complex regulations and strict compliance with Virginia-specific laws. Ms. Gallagher’s background in the regulation and compliance heavy industry of finance has given her an edge in this new space that she leverages to help her clients operate successfully in this industry.