Make 15 Lease Revisions When Tenant Is a Legal Marijuana Business

Both cultivators and retailers pose unique challenges.

 

 

You know that standard lease that you use with all of your other tenants? Don’t use it when you’re entering into a new lease with a legal marijuana business. Although you can use it as a starting point template, you’ll have to do some significant redrafting to make it suitable for dealing with the unique legal and regulatory challenges that come with leasing to a marijuana tenant. Here’s a look at 15 key lease changes that you’ll have to make, along with a Model Lease Clause incorporating sample language for each change.

1. Permitted Use of Leased Premises

Challenge: Start with the use clause that lists the activities a tenant is allowed to conduct on the leased premises. Don’t be squeamish about mentioning marijuana. “I’ve seen one-line use clauses vaguely allowing the tenant to operate ‘a lawful cannabis business,’” explains a Colorado attorney. “I’ve even seen clauses that don’t mention cannabis at all.” Of course, a clause that’s too vague will be meaningless and leave the tenant free to use the premises for any activities it wants.

Solution: While advisable for all tenants, listing the precise uses permitted is especially important when dealing with a business as volatile as marijuana. So, state that you’re leasing to a marijuana business and list the marijuana-related activities the tenant may conduct on the premises. Such uses may include, depending on the marijuana laws of your state:

• Prescription sale—list product form, e.g., bud, leaf, edible, drinkable;
• Recreational/Adult use/Nonmedical retail sale—list product form;
• Cultivation—list maximum number of plants;
• Processing of plant parts and resin into products; and
• Storage for transport [Clause, Sec. 1].

2. Tenant Duty to Comply with All Laws

Challenge: “Legal marijuana” is actually a misnomer. Marijuana is illegal under federal law and federal law supersedes state law, including laws purporting to legalize marijuana. Accordingly, marijuana tenants can’t sign on to boilerplate clauses requiring tenants to comply with all “federal, state, county, municipal, and other” applicable laws and making any illegal activity by the tenant a default of the lease.

Solution: Modify the standard compliance covenant to deal with the legal realities of marijuana industry regulation. Strategy: 

• Require the tenant to comply with all applicable state and local laws, including but not limited to the state marijuana licensing and program rules and local zoning ordinances;
• Since compliance with all federal laws is impossible, require compliance with all applicable federal laws to the extent they’re not inconsistent with the tenant’s right to use the premises to run a marijuana business; and
• Leave in the parts of the standard lease form that require the tenant to comply with other federal laws that aren’t directly related to the growth, storage, and sale of marijuana, e.g., the duty to make reasonable accommodations for the disabled under the Americans with Disabilities Act [Clause, Sec. 2].

3. Tenant Duty to Obtain All Required Licenses & Permits

Challenge: Because state marijuana licensing rules are so onerous, successfully applying for required licenses is a difficult and uncertain process that can drag on for months and even years. Marijuana tenants must also undergo constant inspection and meet stringent regulatory requirements just to retain their license.

Solution: Factor the risk of license rejection and revocation into the lease arrangement:

• Option 1: Don’t sign the lease until the tenant actually secures all of the required licenses;
• Option 2: Sign the lease during the application process but make successful application a condition precedent so that you’re not obligated to meet your obligations under the lease unless and until the tenant verifies that it’s received the licenses.

In all cases, spell out the tenant’s duty to retain the license and the landlord’s right to terminate the lease if the license is revoked—or denied or subject to inordinate delay if the tenant hasn’t yet received the license. To the extent the tenant wants the right to be mutual, require it to pay a termination fee covering unamortized brokerage commissions, tenant improvement allowances, rent abatements, and perhaps one or more months’ rent to exercise its early termination rights. In exchange, the tenant may insist on including language requiring your cooperation during the application process [Clause, Secs. 3 and 10(g)].

4. Other Grounds for Early Termination by Landlord

Challenge: The simple fact that marijuana is illegal under federal law even in states where it’s been legalized creates legal risks to landlords that don’t arise when leasing to other tenants, including the potential for: 

• Federal criminal prosecution for conspiracy to sell, produce, or transport an illegal drug;
• Seizure of your property under federal laws providing for forfeiture of assets by those involved in drug trafficking;
• Foreclosure by your bank claiming that you defaulted on your mortgage by leasing to a federally illegal marijuana business;
• Getting sued or prosecuted for a “nuisance” alleging that the smoke, odors, loiterers, or other unsavory aspects of the marijuana tenant’s use interferes with the “quiet enjoyment” of neighbors and other tenants;
• Actions for alleged violations of restricted covenants to other owners of your industrial park, warehouse complex, or other “project,” e.g., a covenant to lease only to “first-class” business operations; and/or
• Tenant rebellions.

Solution: Give yourself an emergency escape by getting the right to terminate the lease early if the pot hits the fan. List the above, along with denial, delay, or revocation of the tenant’s marijuana license “Early Termination Events” triggering your right to immediate termination [Clause, Sec. 10].

5. Structuring of Rent Payments

Challenge: The normal percentage rent formula you use with retail tenants may have unforeseen legal consequences when applied to a marijuana business. The risk is that regulators may deem your percentage rent interest as giving you a beneficial ownership stake in the tenant’s business. And being deemed the beneficial owner of a marijuana business could subject you to disclosure, vetting, permitting, and other regulatory requirements, as well as potential liability as an interest-holder in the business.   

Solution: Recognize the legal risks that come with percentage rent and other profit-sharing arrangements and strongly consider using a flat, rather than percentage-based, rent formula. You may be able to still get a share of a marijuana tenant’s financial success by structuring the flat rate to fluctuate year-over-year based on the marijuana tenant’s annual revenue growth or business performance.

6. Mode of Rental & Other Lease Payments

Challenge: Standard leases typically require tenants to pay rent by check or other financial instrument issued by a bank or other financial institution. But because banks are federally regulated, they’re not allowed to offer loans, checking, credit cards, and other financial services to marijuana businesses. While Congress has proposed legislation to loosen these restrictions, many marijuana businesses still can’t get bank loans or access to other financial services and must do business entirely in cash.

Solution: Be prepared to modify your lease to allow marijuana tenants to pay rent and other lease charges in cash.

7. Warranty of Suitability

Challenge: Like many landlords, your standard lease may include a warranty that the premises are suitable for the tenant’s proposed use. While it may be fine for other businesses, a suitability warranty is generally inadvisable for a marijuana lease. That’s because making premises suitable for a marijuana tenant often requires significant alterations, as well as approval under building codes, zoning, state licensing, and other regulations.

Solution: Remove your boilerplate warranty of suitability and list the improvements necessary to make the premises suitable. Agree to cooperate, but make the tenant solely responsible for securing any necessary permits, licenses, and other approvals [Clause, Sec. 4].

8. Tenant Improvements

Challenge: Marijuana establishments are subject to elaborate premises security requirements that are similar to the rules governing casinos. And if the business intends to grow marijuana on the property, it will need to install special lighting, heat lamps, and other elaborate systems.

Solution: Expressly list the improvements the tenant will need and allocate financial responsibility for installing and removing those improvements. Specifically, a marijuana lease should include language stating that: 

• The landlord must approve all proposed improvements;
• The tenant must make all necessary improvements and alterations at its own expense;
• The landlord doesn’t have to reimburse the tenant for any improvements that are unique to the operation of a marijuana business and have no value to subsequent tenants; and
• The tenant must, at its sole expense, dismantle and remove the improvements the landlord wants removed when the lease ends [Clause, Secs. 4 and 13].

9. Utilities

Challenge: Running a marijuana business often requires extensive utilities use. For example, indoor growing and storage of marijuana consumes copious amounts of water and energy. In addition to abnormally high costs, increased use of water and electricity may heighten the risk of fire, electrical blowouts, explosion, and mold.

Solution: Make it clear that the tenant is responsible for any increases in utilities costs or excessive consumption of water and electricity. Specific protections to consider include requiring the tenant to:

• Get your prior written consent to change or install any water or electrical equipment or appliances in the leased space;
• Comply with all rules, regulations, terms, policies, and conditions of the utility companies that serve your building or center; and
• Pay the costs of any new risers, feeders, circuit breaker panels, switch gear, or other equipment you deem necessary to install to meet the tenant’s energy demands [Clause, Sec. 5].

10. Security & Other Extraordinary Operating Expenses

Challenge: Due to the nature of the product, the need to do business in cash, and regulatory requirements, retail marijuana tenants often need unusually extensive security measures. To get and maintain an operating license, they must configure themselves like fortresses, with exterior walls, access barriers, wall-to-wall surveillance camera systems, exterior lighting, etc., including special vaults, cameras, security guards, etc.

Solution: Require the tenant to reimburse you for any extraordinary security or other operating expenses its marijuana business directly causes you to incur, e.g., nighttime security guards, extra janitorial service, or supplemental HVAC maintenance [Clause, Sec. 6].

11. Common Areas

Challenge: The presence of a marijuana growing, storage, or selling facility on your property could create unusual problems in parking lots and common areas that your standard lease doesn’t adequately address.

Solution: To minimize risk of collateral damage to common areas, make sure the lease requires the tenant to:

• Prevent employees and customers from consuming marijuana anywhere in the premises or common areas; 
• Use ventilation or other mechanical devices or systems to minimize odors and keep them out of shared air circulating systems;
• Implement measures to prevent loitering; and
• Appropriately dispose of waste products [Clause, Secs. 8 and 12].

12. Environmental Impact & Compliance

Challenge: Standard leases ban the use and storage of “hazardous materials” on the premises, defined broadly as including anything “potentially injurious” to public health, safety, or welfare; the environment; or the premises. That language won’t work for the many marijuana businesses that use fertilizers, pesticides, herbicides, byproducts, butane, cannabis waste, and other substances that would fall into the definition of “hazardous materials.”

Solution: Modify the clause to allow the tenant to use the specific hazardous materials it relies on for its operations, which will vary depending on the type of marijuana business involved. Require the tenant to comply with all federal, state, and local environmental regulations in handling, storing and disposing of these materials and ensure that your indemnification provision covers environmental liabilities [Clause, Secs. 7, 12, and 15].

13. Landlord Access & Inspection Rights

Challenge: State security rules require marijuana establishments to limit access to storage, sales, and other sensitive areas. Result: The tenant may not be allowed to let you exercise your normal right to enter and inspect the premises to ensure that it’s complying with all lease requirements.

Solution: Modify your standard inspection clause and establish a procedure enabling you to do inspections without forcing the tenant to violate its duty to limit access to sensitive areas under state law. In many states, owners can carry out inspections of leased marijuana facilities as long as they’re accompanied by authorized tenant personnel. Make sure the lease requires the tenant to pay for any additional expenses you incur in carrying out inspections and reserve your right to take photos and videos during inspections [Clause, Sec. 9].

14. Landlord Right to Seize Tenant’s Inventory

Challenge: Many leases give landlords the right to take possession of the inventory of a tenant that’s in default. The problem is that taking possession of marijuana exposes the landlord to the risk of liability under federal criminal law. 

Solution: The lease should include a disclaimer acknowledging that:

• Marijuana possession is a federal crime;
• The landlord will not seek to take possession of the tenant’s inventory; and
• The landlord will pursue all of its other lease remedies in the event of the tenant’s default [Clause, Sec. 14].

15. Tenant Duty to Indemnify Landlord

Challenge: Leasing to a marijuana business is riskier than leasing to most other businesses. As a result, the standard lease clauses requiring the tenant to indemnify and hold you harmless for various kinds of harms within the premises may not be enough to protect you.

Solution: In addition to the standard indemnity, add language requiring the marijuana tenant to indemnify you against: 

• Damage to the building, common areas, and other tenants’ premises as a result of robberies, break-ins, and burglaries—for all the security required, cash and high-quality cannabis make marijuana facilities a favorite target for robbers;
• Criminal prosecution, forfeiture seizures, and the other events triggering default and immediate termination rights that we discussed in Section 4 above; and
• Environmental liabilities due to its use, storage, and disposal of hazardous materials [Clause, Sec. 15].