Last week, federal Judge Marsha Pechman sent an ominous signal regarding the enforceability of cannabis contracts by issuing an Order to Show Cause, in which the parties have to show why the court should not dismiss the case. If the parties cannot show cause under the Order, the case will be dismissed based on the contract at issue’s unenforceability – a decision that should send a shiver down every cannabis business. This dismissal would not be precedential, but it would send a strong signal about how federal courts will treat contracts concerning cannabis.
The case, Left Coast Ventures, Inc. v. Bill’s Nursery, Inc. (case no. 2:19-cv-01297), revolves around defendant Bill’s Nursery, Inc. (“Bill’s Nursery”) alleged breach of an option agreement whereby plaintiff Left Coast Ventures (“Left Coast”) allegedly had an option to purchase Bill’s Nursery. Left Coast claims that Bill’s Nursery reneged on the agreement and filed suit.
The lawsuit was originally filed in Washington state court but was removed to federal court based on diversity jurisdiction.
The Order to Show Cause states that the contract at issue may be unenforceable under the federal Controlled Substances Act (“CSA”) because it concerns cannabis businesses, and cannabis remains an illegal substance under the CSA. Generally, the longstanding Erie doctrine provides that federal courts follow state substantive law, so contract issues are dictated by state law. Judge Pechman distinguished from that and stated,
Although Washington law governs the breach of contract claim, “where it is alleged that an agreement violates a federal statute, courts look to federal law.” Polk v. Gontmakher, No. 2:18-CV-01434-RAJ, 2019 WL 4058970, at *2 (W.D. Wash. Aug. 28, 2019) (citing Kelly v. Kosuga, 358 U.S. 516, 519 (1959) (“the effect of illegality under a federal statute is a matter of federal law”).
Judge Pechman cited directly to Polk v. Gontmakher, another cannabis contract case that was dismissed earlier this year on similar grounds. It would be a strong signal for a second case to be dismissed on unenforceability in a few months, and both here in Western Washington, which has had state-legal cannabis for seven years now.
It is not necessarily surprising that a federal judge would have this opinion, but what is notable is that we are getting these opinions in 2019, many years after cannabis was legalized. This certainly was not the first time contract enforceability between cannabis companies has come up.
If federal courts are willing to find whole contracts unenforceable due to the illegality of cannabis, then it is difficult to imagine how much weight specific provisions within those contracts would have. That said, it is still a good idea to include provisions in contracts acknowledging the federal illegality of cannabis, including a covenant that the parties agree not to raise the argument of enforceability in litigation. Most of these contracts are still litigated in state courts where they will still be held enforceable, and the risk of federal court does not negate the good sense of having a well-drafted agreement.