Commercial Leasing to an Arizona Cannabis Business
As with most commercial leases, cannabis businesses have industry-specific peculiarities to which landlords and tenants should give due consideration.
This article specifically addresses issues that commercial landlords and tenants should address, negotiate and resolve prior to entering into a lease of a dispensary, cultivation facility and/or kitchen, extraction or production facility under the Arizona Medical Marijuana Act, or “AMMA” (A.R.S. §§ 36-2801 et seq.) We will refer collectively to those facilities as a “marijuana facility.”
In this discussion, we will expand upon our other articles and presentations that describe or suggest general best practices in Arizona commercial leasing transactions involving marijuana businesses.
Arizona voters approved the AMMA in 2010, permitting persons (patients) with certain debilitating medical conditions (such as cancer, epilepsy, PTSD and unresolvable pain) to register for the State’s approval to purchase small amounts of marijuana in various forms from State-licensed dispensaries. Because Arizona has not yet enacted an adult-use (or recreational) cannabis program, this article will address only commercial leasing transactions of medical marijuana facilities.
LEASING TO A MEDICAL MARIJUANA FACILITY – GENERALLY
Whether you are or you represent a medical marijuana facility landlord or tenant, the following issues are generally applicable to all marijuana facilities.
Compliance with Law: A Solid Business Practice, but Not a Shield. This issue is likely the most important to address and the most problematic for both landlord and tenant. Generally, a tenant must operate its business in compliance with law, whether or not the lease includes a compliance with law provision. “Compliance with law” includes laws specific to the type of business (for example, a restaurant is required to operate a clean establishment) and laws applicable to all businesses (for example, illegal vice activities must be avoided).
In Arizona, a marijuana facility can operate its business (the cultivation, production, and sale of medical marijuana) only if it has a State-issued dispensary license or is affiliated with a licensed dispensary. It must also have an “approval to operate” the marijuana facility – also issued by the State. And it must operate the marijuana facility in compliance with the AMMA and its rules and regulations.
However, Arizona’s medical marijuana law, the regulations enforcing it, and court cases interpreting the AMMA are of recent vintage and generally not definitive, meaning that only minimal guidance exists for participants in the nascent marijuana industry. These concerns add to the tension that landlords and tenants face in entering the cannabis business world.
Compliance Is Admirable, but … Compliance with the AMMA is a valuable practice, but even a perfect score is not enough to shield from federal enforcement actions persons working at a marijuana facility, patients who legally purchase or use medical marijuana, or landlords who lease their real estate to a marijuana facility. This is true because, notwithstanding the AMMA, the business of medical marijuana remains illegal under federal law.
Under the letter of federal law, marijuana is still an illegal controlled substance under the United States Controlled Substances Act (CSA), which makes it a crime to possess or use marijuana even for medical reasons and despite valid state laws authorizing the medical use of marijuana. Penalties for CSA violations include substantial fines, imprisonment, and forfeiture of property to the federal government for disposal or sale. Thus, a landlord who leases its real estate to a marijuana facility potentially faces substantial risks.
At the same time, as a practical matter, very few federal enforcement actions against persons in the licensed cannabis industry are being filed, and the U.S. Justice Department is more aggressive in prosecuting drug cartels, kidnappers, and major money movers. However, leniency may be seasonal, depending on federal politics and appointments. At local and state levels, drug busts in Arizona for marijuana possession continue to nab small offenders, and the potential continues to exist for Arizona law enforcement activities against employees, patients, and landlords or tenants if the enforcement agency so elects or the AMMA is egregiously violated.
Compliance Is the Tenant’s Responsibility, but … Even more disconcerting is that the landlord’s fate is unquestionably dependent upon the acts (and failures to act) of the marijuana facility tenant and the tenant’s principals, employees, volunteers, contractors, and other agents and representatives in the marijuana facility. Noncompliance with the AMMA by a tenant directly impacts the landlord in the event the facility is closed, the State files suit to revoke the marijuana license, or a fire in a production facility reveals emission-control failures or hazardous materials releases. Violations of marijuana laws may ultimately lead to the forfeiture of a landlord’s real estate as an ultimate noncompliance penalty.
Although Arizona requires the marijuana facility’s adoption of good business practices, policies, and procedures applicable to its operations, and the State makes a physical inspection of the facility prior to its opening and periodically thereafter, wise landlords in this industry conduct an expansive due-diligence investigation of the dispensary and its affiliates prior to executing a lease. General rules of due diligence described below apply equally to the potential landlord and tenant. Tenants with extensive business practices are a better and safer bet for landlords with prime real estate.
To Protect the Facility and the Real Estate, a Wise Landlord Should:
- Obtain a dispensary agent card. Consider having one or more principals obtain a State-issued dispensary agent card with respect to the marijuana facility, entitling the cardholder to enter the premises to which, without such card, they would be barred from entry. The dispensary will make the application to the State for this card, and the applicant will need to submit fingerprints and pass a background check.
- Identify the hierarchy of the dispensary and its affiliates. The following questions are important to solidifying lease terms: Who owns the dispensary license? Who sits on its board of directors (if a corporation) or has a membership interest (if an LLC)? Who manages the dispensary, and is there a written management agreement? Who will be the tenant’s contact person? Who owns the dispensary facility? The cultivation facility? The production, manufacturing or kitchen facilities?
- Consider requiring one of the affiliates, or the principals of the dispensary and/or its affiliates, to be the personal guarantors. Often, the dispensary is managed by an LLC whose owners/members are the directors of the board of the dispensary. These persons or the managing entity itself are great candidates to guarantee the lease because they control the dispensary’s money.
- Obtain copies of the dispensary’s practices, policies and procedures. Incorporate these documents into the lease’s provision on ”compliance with law” (addressed above), operational conduct, use of the premises, and access and inspections. Require the tenant to deliver to landlord a copy of all of the State’s inspections of the facility. A notice of violation issued by the State should be a tenant default. Consider hiring a cannabis consultant to perform an inspection as a follow-up to each State inspection.
- Obtain copies of the dispensary’s State-issued license, the ATO, and zoning clearances. Before any marijuana facility can open for business, it must have an AMMA license (to cultivate, produce or sell marijuana) or have a contract with a dispensary that does. Additionally, the dispensary (for itself and its affiliates) must have obtained a State-issued “approval to operate” (ATO) for each facility. Zoning clearances can be obtained from the county, city or town in which the facility is located; these clearances permit the type of facility to locate as planned. The tenant should deliver these documents to the landlord prior to execution of a lease.
- Include comprehensive “compliance with law” provisions. The lease should require the tenant to take all actions necessary to comply with all applicable laws and any change thereof. The tenant should acknowledge and agree (a) to be familiar with the AMMA and understand its application and all other laws to its operation of the marijuana facility, and (b) that the tenant’s ignorance of the law is not a defense to any lease default or super default. (See the “super-default” provisions discussed below.)
CANNABIS-SPECIFIC LEASE PROVISIONS
Although not exhaustive, the following lease provisions should be included in a marijuana facility lease, in addition to those particular to the real estate being leased and with consideration to your attorney’s edits and comments.
Cannabis-related “What If?” Provisions. More so than leasing to a restaurant or a retail store, a lease to a marijuana facility should address what happens in the event of the occurrence of a “super default.”
A super default goes to the very purpose of the lease and destroys it. Examples include the following:
- A federal or state enforcement action is filed against the facility or its principals.
- The marijuana license of or contract with the dispensary is revoked or not renewed.
- The marijuana facility receives a notice of violation from the Arizona Department of Health Services that is not promptly cured.
- Marijuana becomes illegal in Arizona.
- The marijuana facility repeatedly or materially violates law.
Consider including these provisions applicable to a super default occurrence:
- Include provisions that all marijuana and products thereof are owned solely by the dispensary and, because the landlord is not licensed to possess marijuana, the landlord disclaims any interest in it.
- Require the tenant to deliver to the landlord a copy of all keys to the locks of the premises’ doors, a list of all secured passwords to the premises, and access to all security cameras (and videos) and other security equipment relating to the premises, including inside the buildings on the premises. The AMMA requires substantial security provisions, all of which landlord should have access to when appropriate.
- The lease terminates on written notice of a party, without an opportunity to cure.
- New marijuana activities cease immediately.
- The lease terminates within 30-60 days after notice to permit removal of marijuana in the facility.
- The landlord may petition a court to appoint a receiver over the business in the facility.
- The landlord may initiate a foreclosure action on the tenant’s personal property, including various permits, via Uniform Commercial Code secured creditor rights laws.
One Person’s Perfume Is Another Person’s Stink. Another situation arising by virtue of the cannabis business operating in the marijuana facility is noxious smells – e.g., smokers/users loitering outside the premises, or the emission or release of hazardous substances from the production or extraction of marijuana derivatives. These can result in negative consequences to the landlord from complaining adjacent tenants, nearby residential neighbors, and fire and law enforcement agencies.
Consider including provisions minimizing the consequences of stink, smoke, and environmental hazards:
- Comprehensive hazardous materials provisions prohibiting the generation, use, treatment, storage, release and disposal of hazardous substances in or from the premises, except with the landlord’s prior written discretionary consent. Include broad indemnifications, insurance, and covenants for the benefit of landlord. These provisions need to survive the termination or expiration of the lease so that the landlord’s protections continue to apply post-lease.
- Require the landlord to give written notice to tenant of the alleged stink, smoke or environmental hazard and to participate in tenant’s efforts to minimize, reduce or eliminate such problems by initiating modifications to the premises, the installation of a new HVAC system, or upgrades to various waste disposal systems as capital improvements.
- An emergency repairs provision permitting the landlord, at its option, and the Arizona Department of Health Services to enter the premises for the purpose of inspecting conditions in or of the premises, verifying tenant compliance with the lease and laws, and effecting repairs and replacements needed as a result of the emergency. All costs and expenses of the access and inspections should be promptly paid by the tenant.
- Prohibit smoking – of cigarettes with or without marijuana – and vaping and the use of any marijuana product on the premises, inside and outside. Most local governments prohibit the use of cannabis in public places. Permitting employees to smoke on premises encourages neighbors and law enforcement to assume they are toking.
- Require a private trash disposal agreement instead of the facility’s use of public trash disposal services. Public dumpsters on the premises are not locked, resulting in frequent “dumpster diving” by non-patients intending to retrieve marijuana remnants for use or sale. These persons can be injured in such incidents and potentially expose landlord and tenant to personal injury claims.
- Require an initial and annual inspection of the premises and the equipment used therein to determine whether the equipment is operating in compliance with law and there are no improper emissions.
The peculiarities of commercial real estate leasing of medical marijuana facilities (a dispensary, cultivation facility, kitchen/extraction or production facility and otherwise) in Arizona require both landlord and tenant to fully consider the impact of local, state and federal laws regulating marijuana use, production and sale. Numerous lease provisions unique to the cannabis facility lease are suggested by this article. Both the landlord and the tenant should seek the assistance of an Arizona-licensed attorney with experience in drafting and negotiating cannabis facility leases.