Lending in the Marijuana Sector: Ways to Minimize Legal Risk

As of January 1, 2019, ten states have legalized the growth and sale of recreational marijuana. Another thirty-three states permit the distribution of marijuana for medicinal purposes. Each year, more and more legalization initiatives appear on ballots across the nation. Accordingly, it is safe to say that there is a huge market for the drug throughout the country and, when there is a market for a product, it naturally follows that there is an equal demand for capital to increase and improve production and distribution capabilities.

Although lenders of all shapes and sizes generally desire to make loans to individuals and entities working in the marijuana sector, the making of such loans remains fraught with risk. Marijuana is considered a Schedule I controlled substance and is illegal under the Federal Controlled Substances Act. Even in jurisdictions such as the District of Columbia, in which the use of marijuana for medicinal or recreational purposes has been legalized, anyone involved in cultivating, processing, distributing or selling marijuana for any purpose, as well as those who knowingly facilitate these activities, are subject to potential federal enforcement actions, including criminal prosecution, civil actions, and the seizure or forfeiture of property.

Despite these risks, several of our non-federally chartered lender clients have reached out for advice on how to minimize their legal exposure when making marijuana loan transactions. The following are some ideas to consider when documenting loan transactions to borrowers in the marijuana sector (note, specific clauses mentioned below are theoretical only and you should consult an attorney licensed to practice in the jurisdiction where you are making your loan to ensure compliance with all applicable law):

Collateral: Essentially all States that permit the growth and sale of marijuana for medicinal use or that have decriminalized marijuana for recreational use have a cap on the amount of marijuana any one person or entity can possess if that person or entity is not otherwise licensed by the State. This limitation could severely restrict a lender’s ability to seize a dispensary’s inventory under a traditional security agreement or financing statement upon an event of default. Accordingly, if a lender wishes to collateralize a dispensary’s inventory as part of its underwriting requirements, it may be wise to require the borrower under the security agreement and/or loan agreement governing the transaction to sell its inventory to a different licensee upon an event of default.

Compliance with Local Laws: Because the cultivation and distribution of marijuana is illegal under Federal law, it is imperative that borrowers follow the State law in which they are licensed to operate. Failure to comply with both state and federal law is the surest way for a lender to finds itself with a financially defunct borrower whose collateral can literally be seized overnight. Accordingly, lenders should almost always have a clause similar to the following in their loan and security agreement to ensure they have the ability to put a borrower in default before the bank’s collateral disappears, particularly when real estate is collateralized: “The parties acknowledge that myriad regulations and local, state, and federal laws and private persons shall govern the operation of borrower’s use of the Secured Property and that Borrower shall at all times remain responsible for compliance with all mandates and requirements of any nature. The parties also acknowledge that under federal law, the production, distribution and sale of cannabis remains a violation of the Controlled Substances Act and that, as between Borrower and Lender, the risk of enforcement of such laws remains with Borrower under the Loan is satisfied in full. Borrower’s foregoing obligations shall encompass (i) all state and local laws and regulations from any governmental authority with jurisdiction over Borrower’s use of the Secured Property and local zoning ordinances; and (ii) all federal laws to the extent those laws are not inconsistent with state and local laws allowing Borrower to use the Secured Property as contemplated hereunder. The covenant to comply encompasses all applicable laws that become effective before and during the life of the Loan, as may be extended (collectively, the “Mandates”), regardless of the cost of such compliance. Borrower’s failure to comply with the Mandates, in Lender’s sole and absolute discretion, shall constitute an Event of Default hereunder.”

Right to Inspect: In order to ensure that marijuana borrowers are complying with all applicable local and State laws, lenders should ensure they have a right to inspect the borrowers’ production and/or distribution facilities during the life of the loan: “Lender shall have the right, at any time and from time to time, to inspect any portion of the Secured Property occupied by Borrower and its principals, agents, or contractors, including at times when the Borrower is not utilizing the Secured Property to conduct normal business operations and to enter the Secured Property for the purposes of ensuring compliance with the covenants, warranties, and representations of Borrower under the Loan Documents.”

Indemnification: In addition to standard indemnification clauses that may be used in traditional loan documents, lenders to marijuana businesses should consider incorporating additional language to cover special violations of law that may arise from marijuana businesses: “Borrower agrees to indemnify and hold harmless Lender from and against damages or losses Lender incurs as a result of (a) any early termination clauses included in any lease between Borrower and any landlord of Borrower during the life of the Loan, (b) any violation of the Controlled Substance Act, and/or (c) damage done to the Secured Property as a result of robberies, break-ins and burglaries.”

The attorneys in Lerch Early & Brewer’s Commercial Lending Group have over 100 years of combined experience representing lenders and borrowers alike in all different kinds of complex lending transactions. If you are considering making or obtaining a loan relative to the marijuana industry (or any ancillary industry), please contact Alison Rind at by phone at 301-657-0750 or by email at [email protected]. We are happy to discuss your transaction and to assist you all the way through closing!