What Cannabis Companies Should Know About the Federal Illegality Defense

What Cannabis Companies Should Know About the Federal Illegality Defense

Could a federal court refuse to enforce your contract just because cannabis is still illegal under federal law? That’s the issue facing California-based Left Coast Ventures Inc. (Left Coast) as it seeks to pursue a breach of contract suit against a Bill’s Nursery Inc. (Bill’s Nursery), a Florida medical marijuana grower.

Illegality as a Contract Defense

When defending a breach of contract suit, defendants may raise the argument that the contract is unlawful or otherwise void as against public policy. The consequences of an illegal contract can be devastating. Once an agreement is deemed illegal and void, the court will often refuse to enforce it. Under New Jersey case law, an illegal provision or a term contrary to public policy may be severed if it does not defeat the purpose of the whole contract. In addition, an illegal contract may sometimes be enforced to avoid harming a person intended to be protected by the law, or to avoid an unjust forfeiture.

Similarly, illegal promises will not be enforced in cases controlled by federal law where doing so would command unlawful conduct. Kelly v. Kosuga, 358 U.S. 516, 519 (1959). However, even where aspects of a contract might conflict with federal law, federal courts may enforce contract obligations based on policies of (1) avoiding windfalls or forfeitures, (2) deterring illegal conduct, and (3) relative moral culpability. Bassidji v. Goe, 413 F.3d 928 (9th Cir. 2005).

Left Coast Ventures, Inc. v. Bill’s Nursery, Inc.

In 2015, Bill’s Nursery sought to obtain potentially lucrative medical marijuana licenses in Florida. Left’s Coast’s assignor, Privateer Holdings, Inc. (Privateer), entered into an agreement with Bill’s Nursery whereby Privateer would contribute its unique know-how and resources in preparing the medical marijuana license applications, would locate the statutorily required medical director, and would pay substantial application fees to the Florida Department of Health. In return for that and an additional $25,000 fee, Privateer purchased an option for it or its designee to buy all the stock of Bill’s Nursery within 90 days of issuance of a medical marijuana license.

Bill’s Nursery ultimately was awarded such a license, based upon the application that Privateer prepared. When Left Coast (now Privateer’s permitted assignee) attempted to exercise its option, Bill’s Nursery rejected Left Coast’s attempt. Left Coast filed suit in Washington state court, seeking, among other remedies, a court order requiring Bill’s Nursery to honor the option. After removing Left Coast’s complaint to the United States District Court for the Western District of Washington, Bill’s Nursery filed a Motion to Dismiss.

Order to Show Cause

After concluding that the contract at issue may be unenforceable under the Controlled Substances Act (CSA), the court ordered the parties to show cause why it should not dismiss the action. In her order, Judge Marsha Pechman wrote:

Ordering specific performance, in this case, may require mandating illegal conduct. In a similar case from this district, the plaintiff sued his former partner in a marijuana growing business, alleging he was entitled to an ownership interest in the business and past and future profits. Noting the nuanced approaches to the illegal contract defense, the court distinguished between awarding the plaintiff damages, which may have been permissible, and granting his request for an ownership interest in a business that was illegal under federal law. Similarly, the Plaintiff here is seeking an ownership interest in a marijuana distribution business.

Both parties have responded to the Order to Show Cause. In its response, Bill’s Nursery argued that the court can’t order specific performance because doing so would violate the CSA. “Ninth Circuit case law is clear that courts may not order an illegal act. It’s also clear that the sale, distribution, and cultivation of marijuana is illegal under federal law,” Bill’s Nursery wrote. “Recent case law in this district clarifies that while a court may take a nuanced approach to contracts intertwined with state-sanctioned medical marijuana businesses, no court may award an ownership interest in a business whose operation is illegal under federal law.”

In its response, Left Coast maintained that it is not seeking to compel the production or distribution of cannabis; rather, it seeks only to compel Bill’s Nursery to honor Left Coast’s option. “Because the relief sought by Left Coast does not ‘mandate illegal conduct’ this Court has the authority to enforce the parties’ respective obligations under their state-legal contract,” the company wrote.

Left Leaf further argued that even if the court did find the contract at issue runs afoul of the CSA, the public-policy factors established by the Ninth Circuit for assessing a federal illegality defense strongly support enforcement of the contract at issue. “To hold otherwise, particularly at the pleading phase, would constitute an unprecedented expansion of the federal illegality defense in the cannabis industry, promote rampant forum shopping in cannabis-related disputes, and create potentially perverse incentives to operate outside of— instead of within—the legal and regulated cannabis industry,” Left Coast wrote.

Addressing the Federal Illegality Defense

The good news is that most cannabis suits are litigated in state courts, where contract illegality is irrelevant provided the state has legalized cannabis. However, given that federal courts are still raising the issue of federal illegality, it is advisable to take steps to reduce the risk that your suit may get dismissed should it end up in federal court. To be proactive, cannabis contracts should contain provisions acknowledging that cannabis is illegal under the CSA and agreeing that the parties will not to contest enforceability in litigation arising from the contract.

If you have any questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Dan McKillop, at 201-806-3364.

This article is a part of a series pertaining to cannabis legalization in New Jersey and the United States at large. Prior articles in this series are below:

• Is United Approach the Key to Adult-Use Cannabis Legalization?
• Cannabis Industry Celebrating House Passage of SAFE Banking Act
• What Can Cannabis Businesses Learn from Curaleaf?