Facts

Indian Hills Holdings, LLC, (IHH) a California company, used a broker to purchase modular cannabis cultivation cubes. The broker, Christopher Frye (Frye), principal at Construction & Design Professionals, Corp, (CDP) an Arizona corporation, promised to obtain the cubes from a third-party, ICT Centurion Investments, LLC, (ICT) a Colorado LLC with suspended status. Full payment of $182,000 was made to Frye. The Cubes were not delivered. ICT had sold the Cubes to another party. IHH requested a refund of payment. When Frye failed to return the funds, IHH filed a lawsuit in the US District Court for the Southern District of California for breach of contract, fraud, and unjust enrichment. Shortly the filing, Frye returned $140,000 to IHH leaving $42,000 as the balance of the claim along with fees and attorney costs.

The court granted the Motion for Default Judgment with respect to the claims of breach of contract and unjust enrichment but not fraud. Defendants “Answer to Complaint and Motion to Dismiss” were filed a week before the hearing for Plaintiff’s Motion for Default Judgment against CDP. The court accepted Defendants Motion Nunc Pro Tunc[1] and set a hearing date for the Motion to Dismiss after the Motion for Default Judgment. The court denied the Motion to Dismiss with respect to Breach of contract and unjust enrichment and granted it with respect to fraud. This case summary discusses the district court’s decision regarding both Motions.

Motion for Default Judgment

Breach of Contract

The APA was drafted by IHH but signed only by Frye. Because the APA concerned a sale of goods over $500, the California Commercial Code governed the matter and it requires a written contract signed by the party to be bound for an agreement to be enfoirceable.[2] Frye did sign the APA but had he not, the court found that several exceptions to the Statute of Frauds requirement applicable: 1) an admission as to the existence of a contract and 2) payment for the goods was made and accepted. Several emails demonstrate Frye’s acknowledgement of a contract and payment was made fulfilling the requirements of the exemption.

The APA also contained an arbitration clause which is discussed under Defendant’s Motion to Dismiss.

Fraud

Plaintiffs Motion as to the fraud claim was denied. Plaintiffs attempted to argue that they were not aware that Frey was a broker and not the owner of the Cubes. However, emails were produced to show that Plaintiffs were aware of Frye’s broker position by January 2020.

Unjust Enrichment

California does not recognize relief for a claim of unjust enrichment. However, the court allowed the claim as one for quasi-contractual relief. Plaintiff’s claim pled relief for the funds not refunded and attorney fees in connection with the suit.

Motion to Dismiss

The Motion to Dismiss argues that

1. The court lacked subject matter jurisdiction.
2. Plaintiff’s claims fail to state a claim for relief.

Lack of Subject Matter Jurisdiction

Frye argued in the Motion to Dismiss that the court lacked subject matter jurisdiction due to:

1. The existence of an arbitration clause in the APA.
2. The Plaintiff lacked standing to obtain relief in federal court because a cannabis related contract violates federal law.
3. The lack of diversity jurisdiction.

Arbitration clause

The court discussed requirements for a contract under California law which are:

1. Parties capable of contracting.
2. Consent.
3. Lawful object.
4. Consideration.

The APA did include an arbitration clause and near it were two blanks for the buyer and seller to initial. Neither party initialed this provision. The court found that consent to the arbitration provision did not exist. The court cited Marcus & Millichap Real Estate Inv. Brokerage Co. v. Hock Inv. Co., 80 Cal.Rptr.2d 147 (1998) where the court did not uphold the arbitration clause of a purchase agreement because the sellers did not assent to the provision. It also cited, Martinez v. BaronHR, Inc., 51 Cal.Rptr.3d 523 (2020) where the court upheld an employment-related arbitration agreement not initialed by the parties but found mutually consent because three other terms in the agreement acknowledged the parties’ intent to arbitrate all disputes.

Standing of Cannabis Companies

Frye argued that because Plaintiffs derived its income from selling, growing, cannabis and cannabis-containing products it had “limited standing” in federal court preventing the court from enforcing the APA. The Controlled Substances Act (CSA)[3] prohibits the knowing manufacturing, distribution, possession, or cultivation of a controlled substance. On its face the sale of cubes to grow cannabis might seem to violate the CAS. However, it contains an exemption.[4] The exemption states that the CSA does not apply to any person authorized by State law to manufacture, possess, or distribute, a substance. Additionally, the court discussed Congresses defunding of the Department of Justice’s prosecution where cannabis is legal under state law eventually holding that the contract did not violate public policy.

The court then discussed how the federal courts asserting jurisdiction over a cannabis contract disputes focus on whether such assertion would be a prima facia violation of federal law. Ultimately, the court concluded that it could provide a remedy without requiring performance of the contract. Finding in Plaintiffs favor would result only in repayment of funds tendered and not result in Cube delivery and growing cannabis.

Diversity Jurisdiction

Federal subject matter jurisdiction exists in the presence of a federal question or complete diversity of citizenship between the parties. Plaintiff IHH’s location in California and Frye and CDP’s location in Arizona created diversity of citizenship. In cases arising out of diversity jurisdiction, a federal district court has original jurisdiction where the matter in controversy exceeds $75,000. Defendant Frye claimed that the amount in controversy was less than $75,000 because Frye had paid IHH $140,000. However, the court found that at the time of filing the amount in controversy was $182,000 failing to defeat original jurisdiction.

Failure to State a Claim

The court repeated much of the ground covered in Plaintiff’s Motion for Default Judgement and held that Frye’s Motion to Dismiss was denied for breach of contract and unjust enrichment but granted as to fraud.

[1] Latin for “now for then” which allowed the court to hear the Motion to Dismiss after it held a hearing for the Motion for Default Judgment.

[2] CAL. COM. CODE§ 2201(1)

[3] 21 U.S.C. §801, et seq.

[4] 21 U.S.C. §863(f)(1)