Resolving Cannabis Disputes in New York
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G THE B IN EN V C R H E S A N 8 D 8 B 18 AR CE WWW. NYLJ.COM SIN JUNE 24, 2021 Resolving Cannabis Disputes in New York The Marijuana Regulation and Taxation Act, legalizing adult use of cannabis in New York, has provided a framework for the potential multi-billion dollar, highly regulated industry but passage of the bill is only the first step before growers, distributors and retailers can legally sell cannabis to consumers. BY PAUL D. SARKOZI Super., Sept. 5, 2018), investors sought to assert claims for violations of Massachusetts Uniform Securities By n March 31, 2021, the Marijua- Paul D. Act based on alleged misrepresen- na Regulation and Taxation Sarkozi, tations in soliciting investments in OAct (MRTA) ushered in a new cannabis company. era in New York, legalizing adult use In Dreger v. Dolan, 2019 WL of cannabis and providing a frame- 1897116 (Ill. App. Ct., May 17, 2019), work for what has been projected a majority partner of medical can- to be a multi-billion dollar industry the CCB will begin accepting, review- nabis dispensary was ordered to in the state by 2027. Passage of the ing and issuing a range of licenses make $100,000 distribution to allow bill, however, is only the first step. for, inter alia, cannabis cultivators, minority partner to stay current on Adult-use cannabis will be a highly processors, distributors, dispensa- dispensary licensing requirements. regulated industry. As such, sub- ries and consumption lounges. Af- Finally, in Harvest Health & Recre- stantial steps still need to be taken ter that, the cannabis business will ation v. Falcon International (D. Ariz., before growers can cultivate can- be off and running. And if the track No. 2:20-cv-00035-DLR), a petition to nabis crops, distributors will have record in other states serves as a compel arbitration, revealed a wide- products to ship and retailers can guide, so too will cannabis litigation range dispute seeking termination/ legally sell cannabis to consumers. and arbitration. rescission of a merger agreement, The first steps will proceed this In other states where adult use of the return of $51.7 million, and the summer. cannabis has been legalized, there appointment of a receiver based A five-member Cannabis Control have been a range of sophisticated on alleged misrepresentations and Board (CCB), to be appointed by the court battles. In Arkansas Dep’t of Fin. breaches of representation and Governor, the State Senate and the and Admin. v. Carpenter Farms Medi- warranties. State Assembly, is in the process of cal Group, 2020 Ark. 213, 601 S.W.3d Cannabis and the Commercial Division being formed and will then promul- 111 (2020), multiple challenges were gate and pass regulations. After that, made to the process that was used When parties seek to resolve in awarding and denying a marijua- their cannabis disputes in court in na cultivation license. In Bertolino v. New York, the first issue they will PAUL D. SARKOZI is chair of Tannenbaum Helpern’s litigation and dispute resolution practice. Fracassa, 2018 WL 11291738 (Mass. have to address is whether to seek JUNE 24, 2021 recourse in state court or federal Finally, unsuccessful appli- court. There are many reasons to cants for coveted cannabis li- believe that the Commercial Divi- censes will need to turn to state sion, rather than federal court, court Article 78 proceedings to will be called upon in the first challenge CCB decisions award- instance. ing the licenses. One such bat- First, continued federal illegality tle in the medical marijuana of cannabis under the Controlled industry (which has been legal Substances Act can limit the scope in New York since the passage of what a federal court can do. of the Compassionate Care Act For example, federal bankruptcy 2014) was brought under Arti- courts consistently hold that they cle 78 in Albany Supreme Court will not address insolvency issues earlier this year and recently However, even though medical for cannabis companies because has been transferred to the Appel- marijuana is now legal in 36 states federal courts cannot properly ad- late Division, Third Department and adult use sales are legal in al- minister what is deemed to be an for decision. See Hudson Health Ex- most 20 states, these legacy man- illegal estate. See, e.g., In re Arenas, tracts v. New York State Department datory arbitration provision con- 535 B.R. 845 (10th Cir. B.A.P. (Colo.) of Health, N.Y. Sup. Ct., Albany Cnty., tinue to channel disputes into ar- 2015); In re Johnson, 532 B.R. 53 McGrath, J., Index No. 901198-21 bitration instead of into the courts. (Bankr. W.D. Mich. 2015). Federal (Dkt. No. 56, May 20, 2021); see also There are other practical reasons District Courts have also held that J. Smith, Lawsuit Casts Spotlight on that the cannabis industry has em- they are constrained from impos- New York’s Initial Medical Cannabis braced arbitration. Commercial ing remedies that will be construed Licensing, Questions Scoring, MJ Biz arbitration rules generally stream- as endorsing or participating in Daily, Feb. 26, 2021. line proceedings and limit discov- conduct barred by federal law (e.g., ery. Depositions are often the ex- Arbitration of Cannabis the Controlled Substances Act). Industry Disputes ception, rather than the rule, and See Sensoria v. Kaweske, 2021 WL even where permitted are limited 103020, *6 (D. Colo. Jan. 12, 2021). Parties, however, may seek to in number. Nascent cannabis busi- Second, interstate commerce in- avoid the courts altogether in fa- nesses looking to invest money in volving cannabis continues to be vor of alternative dispute resolu- growing the company instead of illegal. Consequently, New York li- tion. Historically, cannabis indus- resolving disputes may find these censed growers and processors will try contracts have included man- cost-saving features attractive. be dealing with New York licensed datory arbitration provisions. In Finally, so long as recourse to the dispensaries or consumption this way, even if courts refused to courts are not required to compel lounges, and when there are claims enforce cannabis contracts on the or stay arbitration or to confirm an for contract breaches among these grounds of illegality, parties could award, arbitration allows parties entities, such wholly intrastate get an arbitrator to resolve the dis- to resolve their disputes privately. commerce is less likely to give rise pute. Most of those concerns have As such, parties that might be to federal court diversity jurisdic- subsided in state courts where concerned about preparing affida- tion. state laws permit cannabis sales. vits in which they might be forced to JUNE 24, 2021 admit to behavior that constitutes investor’s derivative and direct bia Care, N.Y. Sup. Ct., N.Y. Cnty., a federal crime can, in the first in- claims that that the managers and Schecter, J., Index No. 652126/2020. stance, avoid creating such a public majority investors breached their fi- One issue that is being addressed record. duciary duties and non-compete ob- in the pending motion to dismiss According to an American Arbi- ligations by establishing a compet- is the scope of collateral estoppel tration Association (AAA) press ing cannabis company and freezing and res judicata that the New York release, AAA cannabis caseload in- claimant out. court will apply based on the deter- creased 100% in 2020, totaling $172 In Florida, a recently filed petition minations of the arbitrators. Given million in claims, the seventh largest reveals how parties used arbitration the number of cannabis industry among all industries. Additional to resolve disputes under a joint cases that are being heard in arbi- information provided by AAA Vice venture agreement that impacted tration and their impact on other President Jeffrey Zaino reflects that rights to a medical marijuana li- parties and business relationships, almost a third of cannabis cases cense. See Florida MCBD v. Sun Bulb this issue is likely to recur in cases had claims in excess of $1 million Co., No. 21-CA-001562 (Fla Cir. Ct., throughout the country over the and the average claim amount 20th Jud. Cir., March 8, 2021). In that next several years. exceeded $6 million. Although most case, the claimant asked the arbitra- Conclusion of the AAA cannabis cases were tion panel to determine whether a filed in the western United States Florida grower breached contractu- New York courts and arbitrators (such as Colorado and California), al and fiduciary obligations when it have already been called upon to help where adult use cannabis has been jettisoned a joint venture partner af- resolve disputes involving the medi- legal for some time, there have ter an unsuccessful application for cal marijuana industry—whether in been cannabis cases filed in 23 a medical marijuana license in favor determining Article 78 petitions, as states and New York has the fourth a new business partner, whether described above, or deciding wheth- most cannabis filing. According to the original joint venture partner er to enjoin a sale that would transfer Zaino, most of the disputes arise maintained an interest in the license a medical marijuana license based from: (1) operating agreements, application even after the joint ven- on a letter of intent. See Cresco Labs (2) consulting agreements, (3) ture’s termination, whether trade New York v. Fiorello Pharmaceuticals, management agreements, (4) secrets were misappropriated, and N.Y. Sup. Ct., N.Y. Cnty., Borrok, J., joint venture agreements and (5) the value of the parties’ interests in Index No. 652343/2018 (Dkt. No. 142, purchase/sales agreements. the license application. Oct. 15, 2019). As the industry grows Court filings in aid of or to con- Notably, Justice Schecter is cur- over the next two years and beyond, firm or vacate arbitration awards rently hearing a related case, in there will be substantial opportunity highlight the sophisticated nature which Florida MCBD is seeking re- for New York courts, mediators, ar- of commercial cannabis disputes lief against some of the other par- bitrators and litigators to apply their submitted to arbitrators.