By Cole F. Morgan
California City ordinances require cannabis cultivators and manufacturers to own property or obtain leasehold interest in property before applying for a license to operate. Many landlord and tenants are negotiating their first lease regarding licensed cannabis operations. After the material terms of the lease are negotiated, the parties may incorporate terms into the prevalent AIR Standard Lease form. Do not sign an AIR Lease without making the proper modifications to mitigate potential damages and protect both the landlord and tenant.
Cannabis remains a controlled substance under federal law. However, a modified AIR Lease can address the federal concerns to various degrees. Here are common AIR Lease themes that should be adjusted to accommodate the landlord-tenant relationship involving a cannabis operation.
1) Provisions Requiring the Tenant to Comply with All Laws
Throughout the AIR Lease the tenant is required to comply with all laws and not use the premises for any illegal activity. If a tenant signed an unmodified AIR Lease they would be in breach upon signing based on the federal illegality—certainly not the intent of either party. At minimum, the provisions should be modified accordingly to exempt federal law compliance only to the degree of inconsistency with the cannabis operation.
2) Hazardous Materials
Cannabis is considered a “hazardous material” under the AIR Lease, subject to harsh treatment. The lease should be modified to allow the tenant to possess cannabis for the planned operation without consequence. However, the landlord and tenant should have a mutual understanding of all substances that will be on the premises and modify the lease accordingly.
3) Ability to Terminate
In the event the operation is threatened by federal interference, the landlord and tenant should have the ability to terminate the tenancy. The termination ability helps the landlord reduce, but not eliminate, the prospect of the premises being subject to asset forfeiture. The termination ability helps the tenant cut expenses associated with the lease if the operation must be shut down.
An unmodified AIR Lease does not address the illegality of operating a cannabis business and in turn, fails to address imperative aspects of the landlord-tenant relationship. Landlord concerns include protection from asset forfeiture, ability to obtain financing from federally regulated financial institutions, unknown taxes associated with cannabis operations and adequate financial security. Tenant concerns include the ability to operate without breaching the lease, mitigation of losses from federal enforcement, confidentiality, and flexibility regarding alterations.
4) Financial Security
Tenants will have difficulty obtaining financing from federally regulated financial institutions and could be in default with existing financing due to the institutions’ obligation to comply with federal law. The parties will likely resort to private methods of security to protect the landlord from possible damage arising from federal interference. The security may include obtaining one or multiple guarantors, heavy security deposits or prepaid rent.
5) Real Estate Taxes
Many city ordinances have not been finalized; however, it is known that taxes will be associated with cannabis operations, which could possibly carry over to the landlord. The AIR lease should be modified to shift unknown cannabis tax burdens to the Tenant.
Most premises are not equipped for the cultivation of cannabis or the manufacturing of cannabis-related products and significant alterations must follow lease execution, such as significant power upgrades and security modifications. The lease must reflect the negotiated level of flexibility in the construction of the alterations.
The above list of key aspects involved an AIR lease transaction contemplating cannabis operations is not exhaustive and an attorney should be consulted to address specific concerns of the parties involved. The lease plays a primary role in setting the parties up for a long-lasting mutually beneficial relationship and should not be taken lightly.
Cole Morgan is a corporate and commercial real estate attorney. He has assisted numerous cannabis and non-cannabis clients in the drafting of leases and purchase and sale agreements in the Orange County and Los Angeles areas. He can be contacted through his email: [email protected]