The Gold Rush of NJ Cannabis Leasing – Avoiding a Few Traps for the Unwary
ALM Media
Updated
Photo: Susan Montgomery/Shutterstock.com
It has now been over a month since the pell-mell months of July and August, when we had 13 leases, two options and multiple letters of intent to negotiate, finalize, execute or terminate for various clients in the span of a few weeks in connection with their applications for medical cannabis licensure in the state of New Jersey.
During this past summer, New Jersey decided to double the number of medical cannabis licenses from six to 12. Existing license holders were not eligible to apply for new licenses in this round. New applicants had essentially six weeks to compile a licensure application, file the required licensure fee and paperwork, and submit their no-more-than-300-page application. The application included various background checks, qualifications and submissions intended to show that the applicant had the necessary business knowledge, financial capability, and growing and distribution ability, as the licensure was for both growing cannabis and the distribution of medical cannabis.
Over 825 potential applicants arrived for a mandatory meeting of interested parties in June 2018, which ultimately resulted in 146 actual applications being filed on Aug. 31 (51 in southern New Jersey, 50 in northern New Jersey, and 45 in central New Jersey) for six available licenses. As of Aug. 1, there were over 28,500 approved medical cannabis patients in New Jersey, up from 10,000 in 2016.
Interestingly, the applications called for a tiebreaker, which indicates that site control of a leased or owned site and a letter from the applicable municipality showing support for the given use from the mayor or town council will be taken into consideration as a tiebreaker. This tiebreaker is what led some applicants to span the state, engage brokers or canvas the markets on their own, and attempt to line up and negotiate and sign leases for their sites. Licenses were to be granted with two grow and dispense licenses in the north, two in the central region, and two in the south, with winners announced in the beginning of November 2018.
The leases were intended to be for either:
Grow facilities—likely 75,000 to 100,000 square feet to grow product in; or
Dispensaries—approximately 2,500 square feet to dispense medical cannabis.
It should be noted that site control needed to be demonstrated for both types of facilities as applicants needed to show ability to control both within a particular region.
Particular issues that arose within the leasing context included landlords that were generally unfamiliar with the landscape of cannabis, requiring a lot of up-front education of their brokerage team, their legal team and the landlord themselves that had to occur in a relatively short period of time. Issues included the following as well as many others:
Interplay of federal law under the Controlled Substances Act and state law permitting medical cannabis.
Rent: Use of cash to pay rent versus check or wire transfer due to federal banking issues and inability to use federal banking system.
Security deposit: Whether the applicant had to pay a security deposit up front with the signing of the lease that was refundable if they did not get a license. Remember only six licenses will be granted in November, so many who signed leases will be cancelling them. Whether the deposit is refundable became a bit of a hotly debated topic as time began to wear on.
Prepaid rent: How much rent was prepaid (setting aside bankruptcy concerns regarding prepayment of rent) and whether it was refundable or applicable if the applicant got its license was a hotly debated topic.
Cost per square foot: The amount of rent charged also became a very variable thing as landlords began to realize and exact certain things from potential applicants. Rental rates began to bear limited relation to market pricing in certain markets where towns had indicated a willingness to sign letters in support of either grow or dispensary licenses.
Capital repairs: Normal market norms of who typically pays for capital repairs and replacements also became the subject of unusual conversations as leverage started to shift, given short time periods and desires to have deals signed for applications.
Security: Given that many dispensaries can only collect payment for goods sold in cash, additional focus on site security and how one delivers product and how one removes cash on site needed extra attention that many landlords were not well-versed enough to initially understand or focus on.
Risk of forfeiture and compliance with law covenants: The federal risk of forfeiture and the interplay with a lender and mortgage covenants are areas many novice landlords are not well-versed in, and language requiring the applicant to “comply with all applicable laws” can create trip hazards for the unwary given that federal law noted above will be breached on day one. Thus, language needs to be added to address these situations and appropriately allocate these risks among the parties, rather than ignore them.
Odors and waste: While most leases will not permit onsite sampling or smoking, landlords will want to pay particular attention to clauses that implicate this type of activity to make sure that there is an appropriate allocation of risk and ability to enforce any odor-type provisions. Applicants will want to make sure the provision is not too loose to allow adjacent tenants to create an issue for them with the landlord.
Exclusive use: Both the landlord and the applicant (but mostly the applicant) will want to ensure that no one else is doing what the applicant intends to do onsite from a legal and licensing perspective, but also from a covenants perspective—noting that drug stores, convenience stores, food stores, holistic healing and spas might have language in their leases that could implicate some of the uses that a dispensary might engage in, so care in drafting is very important here.
Purchase options: Because of the potential for escalating rents given the use, applicants have asked for, and in some cases been granted, the right to buy certain facilities that are more stand alone in nature, from landlords. Given the use and the value creation potential, this is worthy of consideration when doing one of these transactions.
Termination clauses: The ability of the applicant to terminate the lease if it is unsuccessful in procuring a license, or if it loses its license, or to expand its business if its license becomes permissible for adult-use, is a critical topic for the lease from the applicant’s perspective. The landlord will be more focused on the ability to terminate the lease if it is reasonably concerned regarding a federal forfeiture action by the DEA or other governmental authority and how that might become operative where the landlord could legally lose its property.
In this ever-evolving space, where 30 states have permitted medical cannabis and nine states have permitted adult-use cannabis, there are many more issues of note that are beyond the scope of this article that come into play in a lease tailored to cannabis dispensing or grow facilities. The goal of this article is to sensitize the reader to the notion that these types of leases are not "business as usual," and that they have their own nuances that should be taken into consideration when drafting and negotiating this type of deal. While cannabis leasing is not the equivalent of splitting the atom by any stretch, it does come with its share of key legal and business considerations that need attention—or they can become traps for the unwary.
Brad A. Molotosky is a partner with Duane Morris in Cherry Hill. He practices in the area of real estate law with a focus on commercial leasing, particularly for the cannabis industry.
