26 April 2016

Here’s the article

It can be found at source here

http://www.cannalawblog.com/california-cannabis-vertical-integration-and-big-cannabis/
The New York Times recently did a story on the merging of big business and the marijuana industry in California, noting that California is currently the world’s largest legal (though we would not exactly characterize it as “legal” – see here and here) market for cannabis. Even though licensing under California’s Medical Marijuana Regulation and Safety Act (aka the “MMRSA”) has not yet begun, and medical marijuana businesses are still not permitted under state law to operate on a for-profit basis, we’re already seeing a massive influx of investors, both in-state and out-of-state, looking to claim their piece of the proverbial pie. And though the profit potential for cannabis in California is high, we think it important to step back and take a look at exactly how large “big cannabis businesses” will be, given the limits California law will be placing on vertical integration.

Recall that the MMRSA, which will regulate medical marijuana businesses, is made up of three bills – Assembly Bill 266, Assembly Bill 243, and Senate Bill 643. Each bill has a unique function, but all three bills contain overlapping language regarding certain aspects of medical marijuana regulation. AB 266 establishes the Bureau of Medical Marijuana Regulation (BMMR), which is vested with the power and authority to develop and implement the rules necessary to enforce the MMRSA (the first chief of the BMMR was appointed in February). Specifically, the BMMR will be tasked with developing the licensing requirements for each of the 17 different types of medical marijuana operational licenses provided for in AB 266.

But, barring a single exception, vertical integration of these 17 different types of medical marijuana licenses is prohibited. A licensee may only hold a California license in up to two separate license categories out of the 17, and the state restricts which combinations of licenses may be held. The biggest exception to the prohibition on vertical integration essentially states that if your city or county has an ordinance that requires or permits vertical integration, and your business was vertically integrated prior to July 1, 2015, and you’ve been continuously operating and registered with the Board of Equalization, your business will be allowed to remain vertically integrated until January 1, 2026.

Below are the license types established pursuant to AB 266 and SB 643

  1. Type 1 = Cultivation; Specialty outdoor.  Up to 5,000 square feet of canopy, or up to 50 non-contiguous plants.
  2. Type 1A = Cultivation; Specialty indoor.   Up to 5000 square feet of canopy.
  3. Type 1B = Cultivation; Specialty mixed-light, using exclusively artificial lighting.
  4. Type 2 = Cultivation; Outdoor. Up to 5000 square feet of canopy,  using a combination of artificial and natural lighting.
  5. Type 2A = Cultivation; Indoor. 5001 -10,000 square feet of canopy.
  6. Type 2B = Cultivation; Mixed-light. 5001 -10,000 square feet of canopy.
  7. Type 3 = Cultivation; Outdoor. 10,001 square feet – 1 acre of canopy.
  8. Type 3A = Cultivation; Indoor. 10,001 – 22,000 square feet of canopy.
  9. Type 3B = Cultivation; Mixed-light. 10,001 – 22,000 square feet of canopy.
  10. Type 4 = Cultivation; Nursery.
  11. Type 6 = Manufacturer 1 for products not using volatile solvents.
  12. Type 7 = Manufacturer 2 for products using volatile solvents.
  13. Type 8 = Testing.
  14. Type 10 = Dispensary; General.
  15. Type 10A = Dispensary; No more than three retail sites.
  16. Type 11 = Distribution.
  17. Type 12 = Transporter.

The MMRSA establishes numerous restrictions intended to prevent vertical integration, including the requirement that, as stated above, licensees may only hold licenses in up to two separate categories. Large-scale cultivators cannot also hold manufacturing licenses, although small-scale cultivators may. And small-scale cultivators may be able to obtain a Type 10A limited dispensary license. Cultivators and Manufacturers must utilize a Type 11 Distribution licensee to transport all product to a Type 8 Testing licensee, and then to other Manufacturers and to Dispensary licensees. Distributors and Testing licensees may not hold any other type of license. The restrictions are complicated.

Whatever your opinion on state prohibitions on vertical integration, there are a multitude of arguments advanced for developing a complex licensing scheme that precludes vertical integration, including public safety justifications, as well as an intent to prevent just the sort of big businesses many investors are hoping to capitalize on. These regulations mimic the alcohol industry’s tied-house laws, which prevent alcohol manufacturers, distributors and retailers from being “tied” to one another. Tied-house laws emerged following the repeal of Prohibition in 1933 to limit the power of big alcohol businesses and to limit sales of alcohol to consumers. And it’s no secret that every state that has legalized recreational marijuana so far has used alcohol licensing as the starting point for developing their cannabis licensing regime. California will be no exception.

The proposed Control, Regulate and Tax Adult Use of Marijuana Act (the “AUMA Initiative”), which would regulate recreational marijuana entities, goes a step further than the MMRSA, providing for, at a minimum, 19 different types of licenses:

  1. Type 1 = Cultivation; Specialty outdoor; Small.
  2. Type 1A = Cultivation; Specialty indoor; Small.
  3. Type 1B = Cultivation; Specialty mixed-light; Small.
  4. Type 2 = Cultivation; Outdoor; Small.
  5. Type 2A = Cultivation; Indoor; Small.
  6. Type 2B = Cultivation; Mixed-light; Small.
  7. Type 3 = Cultivation; Outdoor; Medium.
  8. Type 3A = Cultivation; Indoor; Medium.
  9. Type 3B = Cultivation; Mixed-light; Medium.
  10. Type 4 = Cultivation; Nursery.
  11. Type 5 = Cultivation; Outdoor; Large.
  12. Type 5A = Cultivation; Indoor; Large.
  13. Type 5B = Cultivation; Mixed-light; Large.
  14. Type 6 = Manufacturer 1.
  15. Type 7 = Manufacturer 2.
  16. Type 8 = Testing.
  17. Type 10 = Retailer.
  18. Type 11 = Distributer.
  19. Type 12 = Microbusiness.

All of these licenses would be distinct from licenses issued for commercial medical cannabis activity pursuant to the MMRSA. The big difference with the AUMA Initiative is that it does allow for vertical integration, with the exception of Testing licensees, which are prohibited from holding any other type of license. According to Section 26053(c) “Except as provided in subdivision (b), a person or entity may apply for and be issued more than one license under this division.” It will be interesting to see how a recreational market that favors big business will play with a medical market that does not. Allowing for recreational vertical integration but not medical vertical integration could prove detrimental to small medical cannabis businesses, which would be a shame given the importance of affordable patient access.

So, there you have it. If the AUMA Initiative passes this November, vertical integration for adult use cannabis businesses could be allowed, though vertical integration of medical cannabis businesses will be disallowed. Of course, it remains to be seen what regulations the BMMR will promulgate for recreational licensees, and we wouldn’t be surprised if some restrictions on total vertical integration are imposed. In any event, these are the types of licensing restrictions that investors should be considering as they plan their move into the rapidly changing California cannabis industry.

http://www.cannalawblog.com/california-cannabis-vertical-integration-and-big-cannabis/