Nicole Howell Neubert & Jay Purcell, Clark Neubert LLP
Since January 2018, when it finally became legal in California for businesses to sell cannabis to anyone over 21 years old, the imagination of our state’s entrepreneurs has focused on creating exciting new cannabis products and technologies. Vape pens, edibles, concentrated oils, tinctures, popcorn and other new infused goods abound—there’s no limit to the originality. But entrepreneurs need a few key things to enter the market, including a Type 6 or Type 7 license from state regulators; a local permit; and manufacturing equipment.
But acquiring and operating equipment is very expensive, a situation compounded by the fact that cannabis companies remain locked out of commercial lending. If an entrepreneur wanted to open a bakery, Wells Fargo might loan them money for industrial mixers and ovens—but not so in cannabis. To fill this gap, many cannabis companies either rent equipment, or rent out their own manufacturing equipment when it’s not in use. In each case, the typical contract is an equipment lease between the lessor (like the landlord) and lessee (like the tenant). To cement these deals, many companies use simple leases, often derived from real estate leases. This approach has its pros and cons. The pro is that it’s fast and inexpensive. The cons are complicated, but they need to be understood by anyone involved in a cannabis equipment lease:
What’s a True Lease? If you own the equipment and lease it to a cannabis company, ensure your lease is a True Lease, because it entitles lessee’s creditors to zero claimon the equipment. True Leases are based on this concept: The property’s value comes back to the lessor someday (just like in an apartment rental). Because the value comes back to the lessor, the assets shouldn’t be imperiled by anything lessee does, including bankruptcy. To determine if it’s a “True Lease,” courts look for four things:
(i) in the actual document, both lessor and lessee represent that it’s a True Lease, not a Finance Lease;
(ii) the lease can be terminated, meaning that it can be cancelled by lessee for defects or other problems, in contrast to a “Hell or High Water” condition common to Finance Leases;
(iii) the lease term is shorter than the equipment’s useful life; again, this is because the property’s value comes back to lessor someday;
(iv) renewal terms or options-to-buy must be for real money, not token prices; this is another way of saying, “at the end of the lease, the property still has value.” A True Lease can be underscored by lessor making a UCC filing for the equipment (while it is in lessee’s hands).
So, bottom line: in a True Lease, the lessor gets the valuable equipment back at the end and can rent the equipment again (for significant value), and there are numerous points in the lease confirming this; and most importantly: the lease isn’t eternal, renewals and buy-out options are expensive, and when the lease ends, the equipment is not beyond its useable life.
What’s a Finance Lease? In a Finance Lease, the lessor puts up the money to buy equipment, and rent payments are designed to repay lessor for the expense. In this case, all equipment value is captured by lessee, and in the case of lessee’s bankruptcy, their creditors can try to claim the equipment. In a Finance Lease, leases can’t be terminated, because they should extend for the entire useful life of the equipment; in a finance lease, unlike a True Lease, renewals or options-to-buy can be priced for token prices, because the assumption in a Finance Lease is that valuable equipment stays with lessee. To confirm a Finance Lease, the parties should:
(i) acknowledge it’s a Finance Lease;
(ii) indicate that lessee instructed lessor to buy the equipment, and lessee selected the equipment;
(iii) price renewals or options-to-buy for little to no money;
(iv) have long terms, or renewals that extend to the equipment’s useful life; and,
(v) be almost impossible to terminate, leading to the idea that the lease will persist, even come “Hell or High Water.”
Finance Leases are like layaway terms – the lessee makes payments and intends to capture the equipment’s whole value. Courts will look for long, unbreakable lease terms, inexpensive renewals or options-to-buy, and evidence that the lessee selected the equipment and instructed lessor to purchase it.
· Lease can be terminated
· Term of lease < Useful life
· Renewal or buy-out terms are expensive
· Lessee Selects Equipment
· Term of Lease = Useful Life
· Renewal or Option to Buy for Low or No $
For property owners who are leasing out property, the True Tax concept is important as well. If a lessor doesn’t include these terms, they may lose valuable tax benefits (like depreciation and expensing). In a True Tax lease, five concepts should present:
(i) when buying the equipment, at least one fifth (20%) of the equipment’s cost comes directly from the lessor;
(ii) the lessor has a profit motive when it leases the equipment;
(iii) at the end of the lease, at least twenty percent (20%) of the equipment’s value remains (in other words, the lease is shorter than the equipment’s life span);
(iv) the lessee doesn’t help finance the equipment’s cost; and,
(v) if the lessee has an option to purchase the equipment, the price is at least fair market value.
If any of these five points isn’t true, the lessor could lose the tax benefits of owning the property, because the IRS sees the lessee as the true owner when, for instance, the lessee can purchase the property for nominal consideration.
Here’s a side-by-side of the three:
Ariel Clark of is one of California’s best and most dedicated business attorneys advising clients in highly regulated, emerging markets. For over a decade, Ariel has been in the trenches of cannabis law and drug policy reform, helping enact industry-defining regulations while building a client list of leading operators, entrepreneurs, innovators, investors, and healers. When the idea of cannabis business law was considered an oxymoron, she committed her practice exclusively to this emerging industry — foresight that was recognized by Rolling Stone, which named her one of 18 “Women Shaping The Culture of Tomorrow.” Ariel’s hard-work, intelligence, and tenacity have earned her a national reputation as one of the industry’s fiercest lawyers. Ariel’s well-recognized leadership is reflected in her inclusion on Cannabis Business Executive’s “75 Most Important Women in Cannabis”; mg Magazine’s “30 Most Powerful Cannabis Lawyers”; Cannabis Law Report’s “Global Top 200 Cannabis Lawyers”; and Entrepreneur’s “Top 100 Cannabis Leaders.” Ariel’s affiliations include the International Cannabis Bar Association, California Native American Cannabis Association, California and National Cannabis Industry Associations, and California Growers Association. She is vice chair of the Executive Committee and serves on the Social Equity Committees of the Los Angeles County Bar Association’s Cannabis Law Section. Additionally, she serves co-general counsel to Chacruna Institute for Psychedelic Plant Medicines; is a member of the Council for the Protection of Sacred Plants; and co-founded the Cannaboss Womxn’s Circle, an active community of professionals collectively advancing feminine leadership in the industry.
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