Colorado Real Estate Journal - March 18, 2015

Documentation and due diligence to avoid the Henny Penny effect

Amy Brimah Managing partner, Brimah LLP, Denver

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Colorado has set the legal and policy standards for implementation of the legalization of medical and recreational marijuana sale and use. In its first report, the Colorado Department of Revenue's Marijuana Enforcement Division indicated that in 2014 nearly $700 million of medical and recreational marijuana was sold in Colorado and at the end of 2014, 322 retail stores were licensed, 833 licenses were issued to retail businesses in general and 1,416 medical marijuana businesses were approved by the state.

All of the licenses involve a real estate component. Representing a party in a commercial real estate transaction related to the marijuana industry requires additional due diligence and documentation of the transaction, regardless of whether the party is a tenant, landlord, seller, buyer, lender or developer connected to real property – documents that paper real estate transactions should be revised to reflect changes in state law regardless of whether or not the transaction involves medical or recreational marijuana if the drafting party wants to control the use of its real property. It is not sufficient to rely on the generic no violation of law covenants in documents to control the use of the property.

Additional provisions, covenants and representations are necessary to protect all of the parties to the transaction. No other industry has the tension between state law and federal law that could potentially result in dramatically different outcomes at the state level compared with the federal level. Until marijuana is removed as a Schedule 1 drug from the Controlled Substances Act, this tension will remain and the papering of the deal requires addressing head-on the additional issues created by this tension. All aspects of the marijuana industry remain illegal under federal law and are beyond the scope of this article.

Assuming the represented party has complied with the state law requirements for medical or retail marijuana, (See Colo. Rev. Stat. §§ 12-43.3-101 to 1102 and recreational marijuana, Colo. Rev. Stat. §§ 12-43.4-101 to 1101, the “Act”), and understands the risks of the potential liability for violations of the federal law, due diligence is still required by all parties to the transaction to protect its interests.

Henny Penny may be right; the sky may be falling, but isn’t that when it is most important to have all the ducks in a row?

Due diligence items to consider related to the property

-Encumbrances. Review all encumbrances recorded against the property. Is the property held free and clear or is it encumbered by a loan? Are there covenants and other conditions that restrict the use of the property? If the property is encumbered by a mortgage, both landlord and tenant should review the mortgage and loan documents to determine if the use is prohibited by the documents. If the documents are silent with respect to prohibiting a marijuana use, each party will have to determine its threshold for risk given the multitude of federal laws that are implicated in the financing and banking aspects.

-Zoning and local law compliance. Of the 321 jurisdictions in Colorado, only 67 allow the sales of medical and recreational pot, 21 allow only medical sales, while five allow only recreational sales. The majority of jurisdictions prohibit medical and recreational sales. If the property is located in a jurisdiction that permits the desired use, the property must still be zoned to permit the use, whether it is retail, medical, cultivation, manufacturing or testing.

-Physical condition of property. Most buildings are not designed for any marijuana use.

This is an area in which working with an industrial design consultant who understands the specific needs of the use would benefit both the owner of the property and the tenant.

-Licensing requirements. In addition to the act, regulations enforced by the MED dictate licensing requirements. All parties should understand the various steps, necessary documents to obtain a license and the implications of failing to obtain a license for the parties and the transaction.

-Insurance. Each party should determine whether the policies required to be carried by it adequately provide coverage as required by the transaction and sufficiently cover the risks.

Various documents

-Lease Issues. Tenants should insist that the use provision state the licensed marijuana use is permitted under the lease. The landlord and tenant each need the right to terminate the lease, but for different reasons. Both parties will want the right to terminate if federal policy changes to enforce the CSA in the states that have legalized marijuana. If the license is lost, each party may want the right to terminate, again for different reasons. The lease should also address security issues, alterations to the property, abandonment and other issues related to furniture, fixtures and equipment. The guaranty or other security also will be a critical issue to landlords.

-Loan documents. Any person making a loan secured by real property in Colorado should review his documents to include affirmative and negative covenants related to the intended use of the property.

-Purchase and sale agreements. Consider the implications in a sale of property that has been used for a marijuana use or will be used for a marijuana use on the disclosures and representations in the purchase agreement to protect the represented party.

Additionally, numerous other documents such as covenants and restrictions and recorded use restrictions in deeds or easement agreements may be required to document how the owner of the property desires to control the use.

Parties involved in the transaction will benefit from upfront due diligence and thorough documentation of the parties’ intent with regard to use of the property.