Real Estate & Land Use

The federal tax reform law that passed in December 2017 included a new incentive, the qualified opportunity zone (QOZ) regime.  The purpose of this tax incentive is to unlock and redirect trillions (yes, trillions) of capital gains into investments into new businesses, and substantial improvements to existing businesses, so long as those businesses are located in a QOZ (generally, designated  low income census tracts from the 2010 census).  The tax world has been abuzz about this enormous opportunity since the IRS issued taxpayer-friendly proposed regulations in late October.  Our summary of the QOZ regime is here, but the basic mechanics are simple: when taxpayers sell appreciated property (e.g., stocks or real estate) they can “roll” the gain into a new investment, with tax benefits for both the original “rolled” gain (deferral and up to 15 percent gain elimination) and the new investment (no tax on future gain).

In our summary, we highlighted the ability to secure QOZ benefits in urban areas, some of which are already attracting investments. QOZ benefits also are available for cannabis-business investments.  There are many QOZs in rural areas that are perfect for grow and processing operations; many urban and suburban QOZs may be good locations for retail outlets and dispensaries.

There are limitations on the types of business that can qualify for QOZ benefits, so no liquor stores, golf courses or sun tan parlors.  But Congress incorporated its “bad business” list from a Code section that has not been changed since 1986.  Accordingly, the “bad business” list does not include cannabis-related activities. (Please don’t ask us to explain why the cannabis industry is punished under one provision of the Tax Code but allowed to take advantage of another provision of the Tax Code; the best we can say is “it’s Congress.”)

So check the map before buying or building. You may find that some locations are more desirable than others, either because it will be easier to raise money from others, save taxes for yourselves, or simply turn out to be a neighborhood in which gentrification occurs more rapidly than normal.

Today we’re highlighting an interesting case out of the 6th Circuit. In K.V.G. Properties, Inc. v. Westfield Ins. Co., 900 F.3d 818 (6th Cir. 2018), a commercial landlord was denied insurance coverage for damage caused to his property by tenants who were illegally growing marijuana there. The landlord leased property to a group of commercial tenants for “general office or light industrial business.” Id. at 820. The DEA raided the property and caught the tenants growing “lots of marijuana.” Ibid. In the process, the tenants caused roughly $500,000 of damage to the property. The landlord evicted the tenants and filed an insurance claim. The landlord’s insurer denied coverage due to an exclusion for losses resulting from any “[d]ishonest or criminal act” by persons to whom the property was entrusted. The landlord sued the insurer, removed the case to federal court, lost, and appealed. On appeal, the 6th Circuit affirmed the district court’s ruling, addressing two interesting issues in the process.

First, the court discusses whether to apply state or federal law to determine if a loss results from a “criminal act.” At the time of the loss, medical marijuana was legal in Michigan under the Michigan Medical Marijuana Act. The court states that “we would hesitate before reading a Michigan insurance policy to bar coverage for a ‘criminal act’ when Michigan law confers criminal and civil immunity for the conduct at issue.” Id. at 822. The court eventually determined that the tenants’ activities were criminal under both state and federal law (more on that below), and so their musings on federalism are not precedential, but it is interesting to note that the 6th Circuit Court of Appeals appears open to the idea of ignoring the federal prohibition on cannabis and applying state law when considering issues governed by state law (such as insurance coverage).

Second, the 6th Circuit provides an important piece of tactical advice for landlords of cannabis businesses. The 6th Circuit ultimately determined that the question of state or federal law doesn’t need to be answered, because the tenants’ activities were illegal under both state and federal law, and therefore were “criminal acts” regardless of the choice of law. They reached this conclusion due in part to the presumption of illegal activity created by the DEA raid, but primarily due to the landlord’s own assertions in the eviction proceeding, including the statement that “[t]enant illegally grew marijuana” and that the [i]llegal growing of marijuana” was a “continuing health hazard.” Per the Federal Rules of Evidence, pleadings are binding statements that can be admitted as evidence against that party in subsequent legal proceedings. The takeaway here is to know your coverages and exclusions. The landlord likely could have found himself with a winnable federalism argument about what constitutes a “criminal act” had his attorney carefully tailored the eviction pleadings to avoid assertions of criminal conduct. Whatever was gained by a speedy eviction was lost by pleading into an exclusion from insurance coverage.

If you are a landlord considering evicting a cannabis business, contact us today. Our cannabis and real estate teams are experienced in these kinds of interdisciplinary issues, and stand ready to assist.

A few months ago, we chronicled a suit that Josephine County brought against the State of Oregon, which challenged the legality of the state’s marijuana laws. On August 30, Federal Magistrate Judge Clarke recommended dismissal of the lawsuit. In succinct fashion, Judge Clarke noted that Josephine County lacks standing to sue the State of Oregon on constitutional grounds because the county is a political subdivision of the state. As additional grounds for dismissal, Judge Clarke explained that the state has not (yet) placed any substantive limitation on the county’s regulation of marijuana, such that there is no live controversy for the court to address.

Judge Clarke closed by noting the hypocrisy of the county’s lawsuit:

Finally, on a practical rather than legal note, the Court is unpersuaded by Josephine County’s argument that the State is “requiring” it to “aid and abet a federal felony.” The County has provided no evidence to the Court that it has attempted to ban any and all marijuana use and production, as would be theoretically required by full compliance with the [Controlled Substances Act]. Instead, the County merely seeks to limit the use and production in rural residential zones, while continuing to allow marijuana use and production in other instances. Apparently the County is only worried about aiding and abetting federal felonies on certain kinds of land and not others.

Judge Clarke leaves open two important substantive issues — whether Josephine County can retroactively prohibit marijuana production in rural residential zones and whether the federal Controlled Substances Act preempts state level marijuana laws. His Report and Recommendation will be referred to a federal Article III judge for review — the parties have 14 days to submit objections.

Josephine County responded aggressively to a recent adverse decision by the Oregon Land Use Board of Appeals (LUBA), bringing suit against the State of Oregon to invalidate the state’s marijuana laws.  The complaint, filed April 3, 2018, argues that the federal Controlled Substances Act (CSA) preempts Oregon’s recreational and medical marijuana schemes.

The LUBA decision remanded a Josephine County ordinance that would have restricted marijuana production on significant portions of land in the county.  The decision was made on procedural grounds and left open several substantive challenges, one of which dealt with the county’s authority (or lack thereof) to retroactively prohibit marijuana production.  The county seeks to resolve this issue outside of LUBA by addressing ORS 215.130(5)—which protects existing land uses that were “lawful” when started—in its lawsuit.  The county asserts that ORS 215.130(5) does not apply to marijuana production, which is prohibited by the CSA.

The county asserts that the state requires it to “allow,” “facilitate,” and “accommodate” marijuana production in violation of the CSA.  Measure 91, which legalized recreational marijuana in Oregon, allowed local jurisdictions to opt out so long as 55% or more of local voters voted the measure down.  Voters in Josephine County voted no by a very narrow margin (17,313 to 17,311), making the county unable to opt out.

The county’s preemption arguments could have broad impact, implicating both recreational and marijuana legalization schemes throughout the nation.

*09/04/2018: An update on the suit can be viewed here.

In Cossins v. Josephine County, issued March 14, 2018, the Oregon Land Use Board of Appeals (LUBA) remanded a recently adopted ordinance to Josephine County.  The ordinance, No. 2017-002, would have restricted marijuana production on land zoned Rural Residential to lots and parcels larger than five acres, effectively prohibiting marijuana production on anything less than a double lot on much of Josephine County’s Rural Residential land.  The ordinance was also intended to apply retroactively, putting existing producers out of business.

Several producers petitioned LUBA to review the ordinance, raising procedural and substantive challenges.   LUBA held that the ordinance met the statutory definition of “rezoning,” which required advance, individual, written notice to affected landowners, and which notice the county failed to provide.  LUBA remanded the ordinance to the county with instructions to provide the required notice and to conduct at least one additional hearing after such notice.

The producers also argued that the ordinance was “unreasonable” and in violation of ORS 215.130(5), which prohibits land use ordinances from having retroactive effect.  In light of the procedural error, LUBA did not reach these two substantive issues.

LUBA has exclusive jurisdiction to review all governmental land use decisions in the state of Oregon.  This is its second opinion addressing a marijuana-related land use decision since the legalization of recreational marijuana.  In its first, Diesel v. Jackson County (2016), LUBA found a complete ban on marijuana production on land zoned Rural Residential to be “reasonable” because more than a million acres in the county were still available for marijuana production.  Various statutes allow local governments to place “reasonable” conditions on the manner that marijuana is produced and “reasonable” limitations on the location of marijuana production.

These decisions highlight the evolving nature of marijuana-related land use regulation and illustrate the need to review the local political climate in addition to any land use regulations already in effect.

A case in Yamhill County Circuit Court in McMinnville, Oregon pits two farms — a vineyard and a potential commercial marijuana grower — against each other, implicating the scope of Oregon’s Right to Farm law. At issue in Mahesh v. Wagner is a proposal by the owner of nearly seven acres of farmland to grow marijuana next door to an established 580-acre vineyard and a 19-acre vineyard currently in development.

Yamhill County initially approved the marijuana farm, as well as a facility that could process more than 30,000 pounds of marijuana per year, but later withdrew approval for the processing facility. The adjacent vineyard owners filed a lawsuit alleging claims for trespass and nuisance because the marijuana farm will “generate foul-smelling particles that will become airborne and migrate by air” to the neighboring vineyards and “negatively impact the quality and suitability of grapes . . . including but not limited to the use of the grapes for wine.”

The Yamhill County Circuit Court denied the vineyard owners’ motion for a temporary restraining order to prevent development of the marijuana farm. Subsequently, the owners of the marijuana farm sought to have the lawsuit dismissed, relying in part of Oregon’s Right to Farm and Right to Forest Act. The court also denied that motion.

Oregon’s Right to Farm statute (ORS 30.936) provides that farming practices on lands zoned for farm use shall not give rise to any private right of action or claim for relief based on nuisance or trespass. This immunity, however, does not apply where the offending farming practice results in damage to commercial agricultural products.

The marijuana farmers contended they are immune from suit because Oregon courts have held that the “mere allegation” of a farming practice is sufficient to invoke immunity under the Right to Farm statute. The vineyard owners countered that the statute explicitly excludes claims based on damage to commercial agricultural products and their allegation of damage to current and future grape crops brings them within the scope of the exception. The vineyard owners also argued that the legislature never intended the statutory immunity to apply to disputes between farms, contending that the purpose of the statute is to protect agricultural lands from the expansion of residential and urban uses.

The Circuit Court agreed with the vineyard owners stating, “The Right to Farm Act does not provide such blanket immunity as to support dismissal of the complaint on its face.” The court, however, also noted that the immunity could be an affirmative defense at a later stage of the case, leaving the issue open for future proceedings after discovery and motion practice.

No Oregon appellate court decisions have considered the question of whether the Right to Farm Act applies to disputes between farmers and courts in neighboring states have come down both ways. The Washington Supreme Court interpreted that state’s statute as prohibiting such use, even though the Washington Right to Farm statute does not have the same explicit exemption as Oregon. The Washington Supreme Court held that the Washington statute is a narrow codification of the common law “coming to the nuisance” defense and that it does not “insulate agricultural enterprises from nuisance actions brought by an agricultural or other rural plaintiff, especially if the plaintiff occupied the land before the nuisance activity was established.” By contrast, a California court of appeals held that California’s Right to Farm statute applies broadly to a bar a nuisance action brought by one commercial agricultural entity against another commercial agricultural entity.

Because the issue remains unresolved in Oregon, it may take further litigation between these parties to bring the issue to appellate review. Even if the exception does permit the vineyard owners to proceed with their nuisance and trespass lawsuit, additional hurdles remain, including squaring the issues with the Oregon courts’ prior rulings that harm alone is not sufficient to find nuisance and that a balancing of interests is required.