California Cannabis Supply Chain Contracts: Recalls

California’s cannabis regime is set up to separate every point in the supply chain into different license types: cultivation, manufacturing, distribution, testing and retail sales, to name a few. Except for a few vertically integrated companies, virtually all cannabis businesses must rely on other companies in the supply chain to get products from farm to consumer.

To that end, our California cannabis attorneys regularly draft “supply chain” agreements, which is a broad term that includes cannabis contracts such as purchase agreements, distribution agreements, manufacturing agreements, supply agreements, license agreements, and so on. We have been publishing a series of posts identifying common issues with cannabis supply chain contracts in California and will continue to do so in the coming months. If you haven’t already read earlier articles on this topic, I suggest you start with the following:

Today, I want to discuss recall provisions. Product recalls occur when the maker or seller of a cannabis good asks downstream sellers or consumers to return the product, usually after discovery of some defect or safety hazard. For example, a manufacturer of a cannabis vaporizer may initiate a recall in the event that it learns that the vaporizer battery can overheat and burn consumers.

Recalls can be initiated by the manufacturer, but can also be initiated by downstream sellers or government agencies. Given that cannabis products often pass through multiple licensees’ possession before making their way to consumers, it’s key to address recall provisions in supply chain agreements. Not doing so can lead to problems and disputes.

One of the most important parts of a recall provision is addressing who is responsible for controlling the recall. Some recall provisions vest authority to control a recall in one party, while some share the responsibility. This can be critical to the extent that recalls involve public messages–the manufacturer of a product, for example, may want total say over press releases that are issued and the action plan in place to control the recall, all of which could affect its image.

Another key provision in recall language is who pays for it. Recalls can be expensive, both in terms of actually undertaking them and in terms of the loss of products in the marketplace. Not addressing who is responsible for paying for a recall is very likely to lead to disputes.

In terms of payment, it’s typical to see licensees downstream from a manufacturer argue that the manufacturer should bear all costs associated with the recall. This seems logical given that many recall-inducing issues are based on how a product is manufactured. However, many manufacturers will try to negotiate carve-outs to require the downstream operator to bear the cost of a recall in the event that the recall.

To see how this works in practice, let’s go back to the battery example above. If, for some reason, the defect in the battery were caused by the distributor (maybe the distributor stored the vaporizers in extreme temperatures which caused them to malfunction), then from the manufacturer’s point of view, the distributor should pay. As you can imagine, even when contracts have well-drafting cost-shifting provisions, this can lead to a lot of headaches in practice and litigation could arise between the manufacturer and distributor over the issue of who was actually responsible for damage and should bear the costs of a recall.

It’s also important for cannabis contracts in particular to consider the regulatory impact of a recall. The California Department of Public Health (CDPH) has detailed recall rules that require a corrective action plan to be drafted and approved by the CDPH before remediation may be undertaken, for example. Licensees who skip over regulatorily required practices may be inviting even more trouble and spending money uselessly on remediating products that they can’t sell. This is area where contracts can play a large role.

Recall provisions are key in supply chain contracts, as are so many other provisions. Stay tuned to the Canna Law Blog for more updates on supply chain agreements.

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