Author: wnnadmin

Avoid Hemp Litigation with a Real Agricultural Production Contract

As everyone knows by now the 2018 Farm Bill legalized hemp production by de-scheduling the crop under the Controlled Substance Act. We’ve written extensively about federal hemp rules and regulations as well as those in California, Oregon and Washington. We’ve also addressed hemp in terms of USDA Organic Certification, international trade issues, and the FDA stance on hemp derived CBD in cosmetics. We’ve also offered a free webinar on West Coast Hemp CBD. We’re on it.

In light of the breaking news that California has opened up for commercial hemp cultivation and that the Oregon growing season had just begun, this post concerns the more granular topic of agricultural production contracts – i.e. the contracts at the start of the supply chain between farmers and consumers.

What is an Agricultural Production Contract (“APC”)?

Broadly speaking an APC is an agreement between producers and contractors for a specific agricultural commodity. These contracts typically specify the production practices to be used, identify the party responsible for supplying the required resources for production, and specify the quantity, quality, and method of payment for the commodity. APCs are used by farmers, ranchers, and agribusinesses to manage risk and control expenditures. Payment is typically predetermined and outlined in the contract.

An APC is one of several ways in which the marketplace handles the purchase and sale of agricultural commodities. Others include cash forward contracts, which concern the sale of a fixed amount of the commodity at a set price for future delivery; marketing agreements, in which a member of a cooperative agrees to sell some or all of a commodity produced through the organization, and futures contracts, in which the sale and purchase of a standardized quantify of a commodity is negotiated for future delivery on a regulated commodity exchange. An APC by contrast means the sale or production of a specified commodity or commodities by the grower to an identified party under an agreement signed in advance.

Lock in your APC and focus on the hemp.

The APC contract model has associated benefits and risks. An APC may help agricultural companies (i) control quality by providing for control over the production methods, (ii) manage supply, and (iii) protect a company’s intellectual property and control the unauthorized reproduction or sale of a crop. An APC may benefit the grower by (i) reducing financial risk by making the contractor responsible for the costs of production, (ii) providing access to capital financing, and (iii) permitting access to new technology or markets.

An agricultural production contract is a complex creature typically governed by state law including the Uniform Commercial Code. Legislators in several states have proposed, and in some cases enacted, laws concerning the terms of agricultural production contracts. In 1990, Minnesota became the first state to enact such laws. Other states, including California, Oregon, Washington, have enacted various statutes that relate to payments, liens, bailments, and duration of the contract.

Why Should I Care?

Because money. (As people say nowadays). The scope and scale of commercial hemp production is likely to dwarf the sort of farming operations that one sees in the recreational cannabis industry. So the dollar values and the corresponding risks are much higher for everyone involved.

Take, for example, a lawsuit filed not long ago in Oregon in which the plaintiff seeks to recover some $57 million from the defendants over an alleged breach of an agricultural production contract (a “Sharecrop Agreement” as defined the complaint). Under the agreement, the defendant agreed to plant, grow, dry, and harvest 13 acres of hemp at 1,450 plans for acre, for a total of 19,000 plants. The plaintiff agreed to pay all actual costs associated with the crop, which plaintiff would then sell, be reimbursed for expenses, with the remaining balance sold a particular price per pound divvied up between the plaintiff and the defendant. At the outset of the deal this may have looked good from the defendant’s perspective – since plaintiff was covering production costs and responsible for marketing and selling the crop. The defendant, however, promised that it would use “best farm practices” and promised to deliver a “top quality product with a minimum of 10% on average CBD oil content as determined by a random test collected by Farmer and Buyer.” But then things went south, according to the plaintiff, when the defendant refused to hand pick the crop (is this what “best farm practices” means?) and failed to meet the 10% on average CBD oil content, and only allowed the plaintiff to pick up half of the 217,227 lbs of crop. The plaintiff claims that the first two allegations reduced the value of the crop and the last amounted to theft that altogether caused tens of millions in damages.

What Should I Do?

Hemp farmers and purchaser of industrial hemp should carefully consider the special issues that industrial hemp presents before entering into contract for hemp production. Here are some of the factors parties to an industrial hemp production contract should consider before signing on the dotted line:

  • Do state laws restrict or regulate the terms of agricultural production contracts?
  • What are the contractual and regulatory consequences for the farmer and buyer who do not quite follow the letter of the law governing agricultural production contracts?
  • What happens if the state licensing authority revokes the growers ability to sell, store, or transfer hemp?
  • What happens if the hemp does not satisfy pre-harvest THC testing?
  • What happens if the hemp does not satisfy post-harvest THC testing?
  • When will the testing for CBD or other components of hemp occur?
  • How is the hemp chain-of-custody maintained and documented, who is responsible for this, what are the repercussions if something goes awry?
  • What happens if the hemp is seized during transport?
  • Who bears the risk of the USDA deciding not to approve the state’s hemp production plan?
  • Are there / should there be limitations on change of ownership during the duration of the contract?
  • Who bears the risk of complying with state record keeping requirements?
  • Who is responsible for testing of hemp for human consumption or hemp items for other industries and to what standards?
  • What happens if the state allows commercial cultivation before or without submitting a plan to the USDA?

As with anything cannabis related (hemp or marijuana), your generic form agreements are not going to fit the bill here. In fact, such agreements often do more harm than good. This means that the next step is integrating the above considerations into your APC along with other particulars using language the courts will enforce – should that be necessary.

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The Business of Marijuana in Oregon: Join Us May 17!

In exactly two weeks, on May 17, 2019, our own Vince Sliwoski will co-chair an all-day continuing legal education (CLE) event in Portland called The Business of Marijuana in Oregon, along with Danica Hibpshman, Director of Statewide Licensing at the Oregon Liquor Control Commission (OLCC). The roster of speakers lined up for this CLE is better than any year to date (you won’t want to miss Nathalie Bougenies‘ presentation on hemp and CBD); and everyone, including non-lawyers, would be well served to attend. For a full event description, including topics, speakers and registration links, click here.

Looking back over the past four years, it is amazing to see how much things have changed in Oregon cannabis. At this point, the OLCC’s recreational marijuana program is fully built out and the Oregon Department of Agriculture (ODA) hemp program has taken off like a rocket. We are proud to call many of these Oregon producers, processors, wholesalers and retailers our clients, alongside the many investors and ancillary service providers we represent.

Sometimes, it is said that pioneers get slaughtered and settlers get rich. Now that the Oregon regulatory groundwork has stabilized, we have begun to see a second wave of entrepreneurs and investors move in on the local industry. Many of these new entrants bring skills, capital and experience from other regulated markets, while others are new to the space. Over the next year or so, we expect to see continued consolidation in the OLCC market, and further escalation in ODA hemp production, processing and sale.

Oregon attorneys and business owners alike need to be familiar with the unique regulatory concepts and industry dynamics that will be discussed on Thursday in order to best serve the Oregon cannabis industry. These concepts include state laws and administrative rules, developments in the highly dynamic federal sphere, and practical approaches to working with and in the cannabis industry. Attendees will hear from regulators, bankers and, of course, lawyers aplenty.

If you are in or around Portland, we hope you will join us on May 17 for an eight-hour survey of Oregon cannabis that is both broad and deep. And if you are a Harris Bricken client or a friend of the firm, please click here to request a promotional discount code, which can be applied to either the webcast, or to in-person attendance.

See you soon.

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Oregon Cannabis Securities: Raising Money Right

The deals in Oregon cannabis are getting very big and much of what we do these days involves mergers, acquisitions and cross border work. It’s amazing this happened so fast. Less than four years ago, as the OLCC began writing rules for the adult use marijuana industry, there was a distinct small business tenor to everything. At that time, our Portland office began forming the first of what eventually became a few hundred local cannabis companies. It was an exciting time, and a typical set-up looked something like this: two founders with limited capital, medical market bona fides and maybe credit card debt, would join forces with an investor and her few hundred grand. This crew would then form an LLC or corporation to grow weed on somebody’s property.

Today, many of those businesses have disappeared for one reason or another, others are humming along, and a few have really crushed it. Despite all of the consolidation in the OLCC world, though, the small deals and simple structures are making comeback. The only difference is that this time it’s on the hemp side. Oregon has seen a staggering increase in registered growers and acreage this planting season, owing to the new Farm Bill and the CBD craze. So here we’ve been forming small LLCs and corporations again, alongside the seven figure deals– and just in time for planting season. Who would have thought?

One commonality among most of these transactions, large and small, is something called “securities.” Simply defined, a security is a negotiable financial instrument (company stock, certain debt instruments, investment contracts, etc.) offered or sold to an investor who lacks real authority to manage the investment. Many of those early Oregon marijuana companies and the new hemp companies have been trading in securities from the outset, even if unaware of this fact. Noncompliant companies have sometimes skated by, but given the liability exposure here–including lawyer liability for bad deals–it’s crucial to get the securities issuance right.

Probably best to find an exemption.

Federal and state securities laws are very complex, but they apply even to small businesses (including cannabis businesses) offering or selling a security to even just one person. Federal law requires that the issuer either: 1) register the offering and sale with the SEC (“go public”), or 2) conduct that offering and sale within a registration exemption. Fortunately, there are quite a few exemptions available, but you’ve got to hit the target square. And even when you don’t have to register, it’s a really bad idea not to make extensive disclosures to offerees and investors in conjunction with any solicitation.

Finally, in addition to federal securities laws, an Oregon cannabis business issuing securities must comply with Oregon blue sky laws and also the blue sky law of each state in which a purchaser is located. For this reason, our cannabis company clients often end up paying registration fees in other states. Those can add up pretty fast and there may be circumstances where it’s just not worthwhile.

All of that said, below are the Oregon small offering exemptions typically used for a new cannabis business, which do not require registration when done correctly.

Sales to Accredited Investors

An “accredited investor” is an investor with special status under financial regulation laws, generally due to high net worth. ORS 59.035(5) exempts transactions between start-ups and accredited investors from registration, so long as there is no public advertising or general solicitation in connection with the transaction. This is a self-executing exemption, which means that no state filing is necessary to take advantage of the exemption.

The “10 in 12” Exemption

ORS 59.035(12) exempts from Oregon registration requirements transactions that result in not more than 10 purchasers within Oregon during any consecutive 12 months. Note that accredited investors do not count as “purchasers” here. Repeat transactions with the same purchaser during a 12-month period also do not increase the number of purchasers (in other words, each purchaser is counted as one purchaser for the 12-month period). To use this exemption, no commission or other remuneration can be paid, and no public advertising or general solicitation can be used.

Federal Rule 506 (Regulation D) Offerings

If you’ve made it this far, I’m not going to thrill you with an outline of SEC Rule 506; instead, there is a good overview of allowed offerings here. Suffice it to say that in Oregon, for any Rule 506 offering, ORS 59.049(3) provides that the local start-up must, within 15 days after the first sale in the state, file a completed Form D (including the state signature page) with the Oregon Securities Division. There is also a $250 filing fee requirement.

The bottom line is that very often, new Oregon cannabis businesses raising money are subject to securities laws. That is true even if the business intends to break federal laws by trading in marijuana, and even if the business is taking on investment (equity, loan, whatever) from just one person. With a new wave of cannabis businesses coming online, it’s important to get it right. The alternative may be getting sued for securities violations–or even cannabis investment fraud–and that’s no fun at all.

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BREAKING NEWS: California Opens Up for Commercial Hemp Cultivation

We have been closely following California’s commercial hemp cultivation licensing law since it was proposed last year as Senate Bill 1409 (see here, here, and here). In March, I wrote about some of the roadblocks to implementing SB-1409’s commercial hemp cultivation programs, and the lengthy review process of the California Department of Food and Agriculture (“CDFA”) regulation which would allow hemp cultivators to register with their county agricultural commissioners.

The CDFA’s regulation was recently approved, and as of April 30, 2019, the CDFA posted applications for registration for commercial hemp cultivation and hemp seed breeders (see here and here respectively). It looks like these respective apps will not be submitted to the CDFA directly, but will instead be provided to county agricultural commissioners in the county in which a cultivator or seed breeder wishes to cultivate hemp. Applicants for commercial cultivation must provide basic information about themselves, as well information about the cultivation site, the purpose of the site (cultivation v. storage), GPS coordinates and other information regarding the site, a boundary map, and certain information about seed cultivars. The seed breeder application is relatively similar.

Despite the fact that these applications are now live, it’s not completely clear how they will be implemented. There are a number of counties in California that restrict or prohibit hemp cultivation. The memo attached to the application itself identifies a number of counties with restrictions: Amador, Calaveras, Glenn, Humboldt, Lassen, Marin, Mariposa, Mendocino, Merced, Modoc, Mono, Monterey, Napa, Nevada, Orange, Placer, Sacramento, San Bernardino, San Joaquin, Santa Barbare, Shasta, Sierra, Siskiyou, Sonoma, Tehama, Trinity, Tulare, Tuolumne, Yolo, and Yuba. Since the application is so new, we haven’t evaluated which of these counties fully prohibit cultivation, but it’s a safe bet that if any of them do fully prohibit it, their agricultural commissioners are probably not going to accept these applications.

But what about counties that don’t say anything or only have some minor restrictions? It’s not clear yet whether counties will try to delay implementing hemp cultivation by claiming that they need to establish local protocol for registration. Ultimately, each county may do something different, and it will take time before we know what the full effect of the law is.

It’s also not clear how this will be impacted by the federal Agricultural Improvement Act of 2018 (or “2018 Farm Bill”). I summarized parts that law in my previous post linked above, but notably for this post, hemp produced per the former 2014 Farm Bill will be permissible. The 2014 Farm Bill doesn’t explicitly allow commercial cultivation, and so it’s not clear how this will play out. What is clear is that once the U.S. Department of Agriculture begins accepting state hemp-production plans for review per the 2018 Farm Bill, California will need to send its plan for review by the USDA. This could affect registered hemp cultivators, but as per usual, it’s not clear how that will happen just yet.

Stay tuned to the Canna Law Blog for more details on California hemp laws.

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