As the cannabis industry continues to expand across the United States, with 38 states having approved at least one form of cannabis (recreational or medicinal), demand for financing grows with it. Because cannabis is still listed as a Schedule 1 drug under the federal Controlled Substances Act, nearly all nationally chartered banks and credit unions and other institutional sources of capital have refused to provide desperately needed credit to cannabis related businesses. In response to this capital void, regional banks, state-chartered credit unions, and private lenders have readily answered the call from cannabis businesses.
Before undertaking a cannabis lending program, however, lenders should engage in basic levels of due diligence to understand the cannabis industry’s licensing requirements and their impact on a prospective borrower’s business operations.
Cannabis Industry and Licensing
The cannabis industry involves a complicated, disparate set of state and municipal statutes and regulations. Uniformity is not a common trait. A cannabis related entity will have to comply with state licensing requirements as well as obtaining zoning authorizations relating to where a cannabis business can be operated. Prior to approving and funding a loan to a cannabis operator, a lender should verify that all necessary license and permits are in place. The first question a lender should ask is does the potential borrower have an approved license? The second question that must be answered is whether the real property is an appropriate location to operate the cannabis business?
Depending on the state cannabis regulatory system, a cannabis operating business may need to be licensed at the state, county, and city level. If any one of these cannabis licenses is not in good standing, the cannabis business should not be operating at the property until it has been returned to good standing. If the license application is pending, a loan can still be extended to the borrower, but there must be strong provisions in the loan documents prohibiting the operation of a cannabis related business unless and until proof of proper licensing has been provided to the lender.
Likewise, a lender must determine that the real estate is located in an appropriate location to legally operate the subject cannabis business. In many cased, the cannabis regulatory system requires different types of cannabis related activities to be conducted at separate facilities. For example, a parcel of property may be zoned for cannabis cultivation but not the actual manufacture or distribution of cannabis. If a borrower is operating at a location that is not approved for the type of activity, the lender should require the borrower obtain a conditional use permit or zoning variance that approves the cannabis related activity prior to the actual operation of the cannabis business at the subject property. Once obtained, the lender should determine that the borrower’s activities on the property to ensure the activities are consistent with the permit or variance. If the borrower’s activities do not comply with the terms of a variance or conditional use permit, the lender should reconsider approving the loan or conditioning loan approval and funding on the borrower’s compliance with the permit or variance.
Even though title insurance companies offering title policies in connection with cannabis related loans is not a recent phenomenon, not all title insurance companies are willing to engage in cannabis-related transactions. A common question raised by lenders entering into the cannabis lending space relates to the availability of title insurance. As the cannabis industry grows and the demand for title services grows, some title companies are willing to satisfy this demand and provide title insurance policies and escrow related services in connection with cannabis related transactions. These title companies have put out guidance on the availability of their services. A title company engaged in cannabis related transaction will provide such services under the following conditions:
- Certain title insurance companies will insure commercial property or raw land in which a cannabis enterprise (dispensary, grow facility, or processing center) is either in current operation, or is contemplated is eligible for operation.
- Insurance limits are generally $20 million.
- If liability limits exceed $20 million and are part of a multi-state transaction, the properties would need to be allocated in a way that the properties being aggregated do not exceed the $20 million threshold.
- The title policy will not offer a zoning endorsement or any other endorsements that discuss the use of the property.
- The title company will not provide a closing protection letter in connection with the transaction.
- Each borrower will have to complete an extensive cannabis-related questionnaire.
- Each owner/borrower will need to comply with all the usual requirements contained in the title commitment in order for the title company to issue a policy such as title affidavits, organizational documents, surveys, and any documentation needed for new construction/mechanic’s lien coverage etc.
- All title commitments and pro forma title policies will contain the following exception:
- Without limiting, modifying, abridging or negating any provision of the Exclusions from Coverage stated in this Policy or any other exception included in this Schedule B, and as a supplement and addition thereto, this Policy does not insure or provide title insurance coverage directly or indirectly for or against any and all consequences and effects, legal, equitable, practical or otherwise, civil or criminal, of any violation or alleged violation of any United States federal, state, county, municipal, or local laws, statutes, ordinances or regulations or any actual or threatened action, court order, or mandate for the enforcement thereof, relating to or governing the use, processing, manufacture, growth, possession, distribution, sale, or any other activity on, about, or relating to or concerning the land, title thereto, or any interest therein, of any Schedule I drug as defined by the United States Controlled Substances Act, including, without limitation, marijuana and/or cannabis, and any component, derivative or product thereof. This Policy insures title only; nothing contained in this Policy shall be construed to insure the subject premises for any particular use.
With cannabis remaining illegal at the federal level, cannabis-related finance is still in its relative infancy and comes with risks not associated with traditional financing transactions. Even with the unique challenges presented by cannabis loans, lenders that who take the time to understand the industry can tap into a growing opportunity and expand their customer base. Fully understanding the risks associated with making cannabis-related loans will enable a lender to underwrite those risks and find workable solutions to mitigate those risks. Any lender contemplating getting into the cannabis-related field should team up with others who have experience navigating the relatively uncharted cannabis waters.
The team at Geraci LLP is well-versed in the nuances of cannabis financing. Contact us today to discuss your options.