Ensuring site control in cannabis licensing
January 27, 2022
Foley Hoag LLP
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In most jurisdictions, applicants must demonstrate some form of site inspection of the site for which they wish to obtain a license to operate a cannabis facility. Finally, while some jurisdictions allow provisional applications, which allow an applicant to apply provisionally without a site or simply identify a site, each applicant must demonstrate that they have control over the proposed site, either in the form of fee ownership, leasehold, option to purchase, or leasehold, or a letter of intent to purchase or lease. There is no best solution or one-size-fits-all approach to this real estate problem, but each approach has pros and cons.
Fee ownership offers the greatest security but is obviously the most significant investment in terms of cost and time. Owning real estate requires basic due diligence from an applicant, including zoning, environmental and property reviews, all of which take time and money. For many applicants, particularly in urban areas and core markets, the upfront cost of acquiring a property without the assurance of a license is simply too risky and/or prohibitive.
An executed lease provides the next best level of certainty after ownership of fees, without the burden of upfront acquisition costs and a reduced burden of due diligence. A properly structured lease can provide an applicant with assurance that they have the unconditional right to operate the intended use of the site for a minimum term of years at a fixed or known cost, and may include the right in advance or pre-negotiated to make targeted improvements execute. Ideally, the lease agreement will include a right of termination for the tenant if they fail to obtain their cannabis license. Without such a right, the disadvantage of entering into a rental agreement is that the tenant is bound by a statutory contract of payment and performance, with significant consequences if the tenant defaults, including the loss of the security deposit, the rent increase and the associated costs and Fees. The strength of a lease is its flexibility, provided it is properly negotiated. A cooperative landlord may grant the tenant a discounted rental structure during the permit or permit period, with full rental obligation only beginning when the facility is operational. The same strength of flexibility can become a nuisance on a poorly negotiated lease if there is too much uncertainty. The dilemma faced by many applicants is that they do not have the time to complete a properly negotiated lease, especially when evaluating multiple locations. This causes them to take the options approach.
Options are a compromise. Basically, these are agreements that are typically frowned upon in contract law, but are made binding through consideration. They are usually shorter than the subsequent document that is executed when the option is exercised (purchase and sale agreement or rental agreement), so they take the least amount of time and upfront costs to negotiate. However, the shorter and less detailed the option, the greater the risk for the option holder. A thoroughly negotiated call option may, in fact, contain the vast majority of the substantive terms that would be contained in a subsequent purchase and sale contract, presenting the option holder with the least risk that the parties cannot agree on a substantive term at the time the option is exercised (usually after the cannabis permit is issued, when the option holder now has the least leverage). A short, two-way option agreement may be sufficient to be legally binding, set a price and give the buyer exclusivity, but the more substantive terms that then need to be negotiated greatly reduce the buyer’s leverage, causing the buyer to trade again by price, if the parties cannot agree on a mutually acceptable purchase document (which is a typical contingency for the successful exercise of an option).
Lease options are somewhat misleading and at their simplest are just a binding letter of intent or at their most complex something like a full lease with the right to cancel. Most letters of intent regarding rentals are expressly non-binding, save for a short period of exclusivity between the parties to negotiate the rental agreement. A letter of intent to lease may be binding if the consideration is some form of option payment, and may provide exclusivity to the option holder. However, the greatest risk arises for the option holder, especially the longer the option term. While a valid and legally binding option to purchase may enable a buyer to perform a specified performance in the event of a seller’s default, such a remedy becomes much more uncertain for the holder of a lease option or letter of intent when it has not been agreed and damages are speculative will. While an LOI or lease option may be sufficient to satisfy cannabis regulators in the application process, once the license is site-bound, the applicant’s risk of being able to negotiate a fair lease once a permit is granted is significantly reduced.
At the end of the day, the best position an applicant can be in at the time of application is to have a mandatory property site inspection document containing as many essential conditions as possible, subject to successfully obtaining the applicable cannabis license ( or otherwise contains a right of termination for failure to obtain) and in a form generally accepted by the courts, common law and contract law in the jurisdiction in which the property is located. Fully negotiated purchase and sale contracts and leases top this list, followed by binding purchase options. Binding letters of intent offer the greatest uncertainty and therefore the greatest risk.
The content of this article is intended to provide a general guide to the topic. In relation to your specific circumstances, you should seek advice from a specialist.
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