The cannabis industry can be a minefield of potential legal, tax, and licensing issues. In particular, cannabis lease agreements can be a hotbed of hidden problems. Many operators have been forced out of business altogether over a dispute with their landlord over an actual or purported lease violation.
Some of the most common — and seemingly innocuous — provisions in a standard lease agreement can be problematic for cannabis tenants and landlords. Cannabis commercial space leases are inherently complex, and a template pulled off the internet will never achieve the appropriate levels of protection for either side.
AdvertisementHere are the top eight potential problems and their solutions.
Many people use lease templates they find online and never run into a problem. However, the vast majority of standard commercial real estate leases include a clause related to “applicable law.” These usually state tenants cannot “use the premises for any unlawful purposes, including, but not limited to, using, manufacturing, selling, storing, or transporting illicit drugs or other contraband, or violate any law or ordinance, or commit a waste or nuisance on or about the premises.” That presents an obvious problem for certain cannabis businesses, since marijuana remains illegal under the federal Controlled Substances Act. The increasing popularity of and continued disputes over the legality of hemp-derived products such as Delta-8 and hexahydrocannabinol (HHC) also are raising concerns.
The Solution: Leases should carve out any necessary exclusions from federal or state laws that might inadvertently prevent the operation of a cannabis business on the premises. In addition, landlords and tenants should explicitly agree on what type of activity will be allowed on the premises (typically referred to as the “permitted use”), and the lease should expressly state the purpose and type of business — e.g., growing, manufacturing/extraction, medical marijuana dispensary, or recreational-use retail store. Being clear at the outset about the products the tenant intends to make or sell during the term of the lease can save a lot of headache — and attorney fees — later on.
The length of the lease term requires careful consideration for each company’s circumstances. For example, tenants typically want a lease long enough to allow their business to become fully operational. This is particularly important for some cannabis manufacturing businesses where the build-out alone can be a year-long process. If it takes one year of a five-year lease to obtain the requisite government approvals and conduct the necessary construction and renovations, not much time remains to operate before the tenant has to re-sign — or potentially face moving if the landlord opts not to renew. On the flip side, many commercial lease terms are five to ten years at a minimum, which can be daunting for a cannabis business that faces more legal and market uncertainty than other types of companies.
The Solution: Tenants should weigh lease length risks and rewards for their circumstances and consider the amount of time needed to get the property up and running. A separate consideration for cannabis businesses is that lessees must have a location secured before obtaining a license. As such, cannabis tenants should ensure any lease executed before they are fully licensed includes a way out tied to the ability to obtain the necessary licenses and permits.
Both landlords and tenants must comply with local zoning regulations. Regulations about where cannabis businesses may be located are strict, as are other zoning considerations, such as the need to provide a certain number of parking spaces for retail locations and clauses about which types of on-premise activities are allowed and which are not.
One significant and often-overlooked consideration is future plans for the area. As the amount of available land decreases and residential properties, schools, and other businesses move further afield, cannabis businesses may find themselves in a bind due to seemingly minor issues like parking or distancing laws. Or, sometimes, as their tenant options expand, property owners prefer not to renew a cannabis business lease and instead rent to a business they consider a more favorable or less risky tenant. Locations with multiple tenants within a single building also can be tricky for cannabis businesses.
The Solution: Tenants should review any future development plans for the location they are vetting. In buildings with multiple tenants, cannabis entities should consider their prospective neighbors, including the types of businesses and the lengths and terms of their leases.
Leases should be contingent upon both the landlord’s and tenant’s strict compliance with applicable local and state laws and regulations, in addition to clearly outlining local zoning regulations and specific leasing considerations that could arise related to operating a cannabis business. These considerations can vary widely depending upon the property, activity type, and jurisdiction, and they are a key reason why each party will benefit from hiring local counsel well-versed in cannabis law and applicable rules and regulations.
Most leases require landlord consent for alterations to the premises. In the context of a cannabis business, extensive alterations may be necessary if there are plans to cultivate, extract, or manufacture, and additional operations may be needed over time. Water, electricity, and air quality/circulation demands also will differ significantly from those of the average tenant. As such, the property may require considerable physical alterations to accommodate a cannabis business, which may impact other tenants in a multi-tenant building.
The Solution: Tenants can save a lot of money on the back end by ensuring up front they have a clear concept of what alterations may be needed and clearly spelling out the landlord’s approach to alterations. The building or location should have the capacity to provide enough electricity and water for current and future needs. This is particularly important if the building in question houses multiple tenants.
As one example, I have a client with a long-term lease for a cannabis grow and retail store who, with landlord approval, invested a significant amount of money in upgrading the building, including bolstering electrical capacity to accommodate their needs. Another tenant seeking to open a cannabis grow moved into the same building without first confirming whether the building had the electrical capacity to accommodate another grow or, if not, whether the electrical capacity could be upgraded (and at what cost). This lack of foresight has limited the new tenant’s business — literally and figuratively. That’s just one reason why tenants always should consider what other businesses may be sharing the property’s utilities when reviewing a potential location.
Ideally, the lease also should state that if the landlord cannot provide access to the necessary services, then the tenant can either pay for the upgrade themselves or terminate the lease. At a minimum, the lease should clearly state which party is responsible for physical alterations to the property and any potential accompanying increased utility costs.
Generic leases usually give landlords the right to access the property at any time. However, many state and local laws impose strict rules about who can enter cannabis facilities, when they can enter, and specific entry requirements. Typically, anyone who steps foot onto the premises of a cannabis facility must sign a visitor’s log and be accompanied by a badged employee — even the landlord.
The Solution: Include terms in the lease that clearly outline the landlord’s access and inspection rights, and establish entry policies that fully comply with all cannabis governing authority and other local and state regulations.
Property insurance can be an issue because most basic policies are not well-suited for a cannabis tenant or landlord. In addition, landlords may require tenants to maintain a certain level of insurance that can be prohibitively high.
The Solution: Both the property owner and the tenant should consult with their insurance brokers before signing a lease and ensure they can comply with all costs and provisions in the policy. The insurance company must know the insurance is being issued for a cannabis-related business to avoid the possibility of the insurer denying a future claim based on federal illegality.
Many commercial landlords base rent on revenues, and it’s also not uncommon for them to take a cut of the business profits as part of the lease agreement; this is termed “profit-sharing.” In most states, however, profit-sharing can mean the landlord has become a “financial interest holder” or even an owner, which is legally allowable only for the actual cannabis business license holder.
The Solution: Tenants and property owners should protect themselves by avoiding profit-sharing clauses in the lease. Instead, base the rent on a flat rate or incremental increases over time without tying it to sales volumes.
Standard lease templates typically prohibit the use and storage of “hazardous materials,” a somewhat ambiguous term that applies broadly to anything “potentially injurious to the public health, safety or welfare, the environment, or the premises.” That type of clause clearly is not ideal for a business that may need to use cannabis—which has itself been deemed a “hazardous material” in certain jurisdictions — or dispose of cannabis waste, byproducts, pesticides, butane, herbicides, fertilizers, or other chemicals.
The Solution: Leases should clearly outline what type of waste may be disposed of and state the business will comply with all proper disposal procedures under federal, state, and local environmental regulations.
In conclusion, establishing a good relationship with your landlord is imperative. Be up-front and honest about what you seek to do and why. Set the tone for a respectful and cooperative partnership from the start.
Both sides should have legal representation that understands the cannabis industry. Corporate or real estate attorneys may be great at drafting leases, but they often don’t have experience navigating the types of issues that frequently arise in cannabis business leasing agreements. Tenants shouldn’t sign just any lease the landlord presents, nor should landlords pull a lease agreement off the internet. Instead, both parties should work together with their attorneys to set clear expectations and put them in writing. Paying a small amount up front to have an experienced cannabis attorney review your leasing document may help avoid tens of thousands of dollars’ worth of trouble in the future.
Every cannabis leasing agreement will have distinct challenges, but they are not insurmountable. A good tenant-landlord relationship, combined with a well-written and comprehensive lease, will go a long way toward a successful future.
Cara Thornton, Esq., is a partner at Fortis Law Partners, where she focuses on complex commercial litigation including intellectual property, business torts, cannabis law, and real estate. She also advises corporate clients on a litany of issues, including contract- and employment-related matters, formation and dissolution, and risk management. From 2006 to 2009, Cara was an Assistant Attorney General of Yap State, the Federated States of Micronesia, where she advised the governor on legislative and policy issues and handled the state’s civil litigation.
