Ninth Circuit Ruling a Warning to Those Doing Business with Cannabis Industry

August 6, 2018 by Paul J. Sievers, Esq.

Since the legalization of recreational cannabis in California and other states, investment in the industry has skyrocketed. However, that investment is not without risk. Marijuana is still illegal under federal law, and even though recent comments from the federal government ease fears of federal prosecution, some investors are still wary of placing their capital with a business that could run into legal troubles.

Investors can minimize the risk of investing by performing proper due diligence on the cannabis company in which they plan to invest, and the principals of that company. Also of concern is the state in which the business resides. Each state has different laws on how they enforce the use and sale of legal cannabis, and it is imperative to know if state regulations are stringent enough to prevent federal interference.

A recent decision by the U.S. Court of Appeals for the Ninth Circuit emphasizes the risks associated with investing in cannabis and the need to scrutinize individuals and businesses before investing. In the United States v. Gilmore, the Ninth Circuit ruled that the federal government has the right to enforce federal drug laws in California against individuals and companies that operate on federal lands.

The background on this decision goes back to 2015, when the U.S. Congress voted to attach a rider in appropriations bills stating that “none of the funds made available” by Congress may be used by the Department of Justice (DOJ) to prevent the implementation of laws pertaining to the use or cultivation of marijuana in states where it is legal. The rider continues to this day, with the most recent Congress extending the rider to the current federal government funding bill, which becomes law on March 23, 2018.

The Ninth Circuit reinforced this intent in United States v. McIntosh, ruling that the practical effect of the rider prevents the DOJ from using funds appropriated by Congress to prosecute defendants if they engage in businesses after fully complying with state medical marijuana laws.

Gilmore Case History

In Gilmore, a tip was provided to law enforcement by local hunters that marijuana was being cultivated on land in El Dorado County, California. During the execution of a search warrant, federal officers found over 100 cannabis plants and arrested three men. One of the men explained that he had leased the property to grow medical marijuana under license by the state, and that the other two men were hired to help.

The DOJ indicted the three men on charges of cultivating marijuana because the grow farm was located on federal land, under the authority of the Bureau of Land Management.

One defendant pleaded guilty, but the other two fought the government by claiming the appropriations rider prevented the federal government from prosecuting them since the cultivation of medical marijuana is legal in California.

The Ninth Circuit disagreed, saying that the DOJ had the right to prosecute because the rider did not limit the DOJ’s ability to enforce federal laws on government-owned land. The court argued that the rider applies only to state systems that permit the legal use, sale, and cultivation of medical cannabis.

The court also noted that California law does not allow cultivation of marijuana on federal land. The defendants argued that they did not know that they were operating on federal land, however, the court said that the prosecution did not have to prove that the men knew they were on federal land and that the defendants’ non-compliance with state law was enough to indict under federal law.

The Benefit of Proper Due Diligence

The defendants’ error in judgment exposed them to prosecution, fines, and the loss of their business. It is not known who invested in the company, but because of their lax diligence, any investors likely lost most, if not all of their investment.

The Gilmore case highlights the need for investors to remain extremely diligent when considering investing in cannabis businesses. Careful examination of state laws, a comprehensive review and evaluation of the business plan by legal counsel, and a firm understanding of exactly how and where the company intends to operate are all necessary to avoid a catastrophic loss of capital.

Failure to perform the proper amount of due diligence and oversight can also expose an investor to fines and criminal penalties, if the prosecution can show that they are intimately involved in any part of criminal and non-protected business operations.