ESG and Cannabis is No Easy Task Right Now

Socially responsible and “sustainable” investing is picking up in popularity across retail and institutional investors alike. According to Wikipedia, “[i]n less than 20 years, the ESG movement has grown from a corporate social responsibility initiative launched by the United Nations into a global phenomenon representing more than US$30 trillion in assets under management.”

When it comes to cannabis though, implementing environmental, social, and (corporate) governance (“ESG”) initiatives may be very difficult to pull off. This could be an issue for future investors looking for more environmentally and socially conscious industries in the U.S. (and even abroad).

If you’re new to the concept, ESG is a scored evaluation of a company’s awareness around various environmental and social/cultural issues when it comes to how it governs itself internally and does business externally. Usually, intangible assets of the business help make up a company’s ESG score, which can seriously increase its future valuations. These intangible assets may include a company’s corporate culture, attention to environmental and social initiatives like climate change and human rights, employee treatment and relations, educational programs around diversity, support of consumer protection, etc.

NerdWallet lays out nicely, into a few categories, your typical ESG factors for companies to consider when integrating the concept:




  • Carbon emissions.

  • Air and water pollution.

  • Deforestation.

  • Green energy initiatives.

  • Waste management.

  • Water usage.

  • Employee gender and diversity.

  • Data security.

  • Customer satisfaction.

  • Company sexual harassment policies.

  • Human rights at home and abroad.

  • Fair labor practices.

  • Diversity of board members.

  • Political contributions.

  • Executive pay.

  • Large-scale lawsuits.

  • Internal corruption.

  • Lobbying.

While cannabis remains federally illegal, I have to question whether overall ESG integration is even possible for certain cannabis licensees on a state-by-state basis (and I’m not talking about cannabis ancillary goods and services that are not subject to the onerous requirements of state and local cannabis licensure).

Regarding environmental ESG considerations, certain cannabis producers/cultivators, depending on state, are in a bit of a catch-22. Even though, for example, cultivators in certain states can grow outdoors and therefore reduce their carbon footprint and potentially their overall environmental impact (especially through adherance to state environmental protection acts), there are other states where outdoor cultivation is entirely prohibited. This forces licensed growers into hugely expensive, energy-intensive, environmentally insensitive indoor grow facilities that produce year round.

Further, given federal policy, growers may have to do all kinds of inefficient things when it comes to water usage given that the Bureau of Reclamation essentially refuses to assist cannabis cultivators when it comes to federally regulated water. Also, lots of green initiatives under federal law likely cannot even extend to federally illegal cannabis businesses (state-based ones may be fair game though).

The regulated cannabis industry is actually well aligned in other ways on some of the ESG social factors, especially when it comes to social justice awareness. Cannabis is uniquely positioned to address and remediate the impacts of the War on Drugs. We see these efforts already through the implementation of various social equity programs on the state and local levels. Further, the cannabis industry has a great opportunity to set itself aside from the perceived societal and public health impact sins of the alcohol, tobacco, and pharma industries by learning from the pitfalls of regulators, stakeholders, and businesses therein and improving on them.

On the governance side, cannabis companies are currently hamstrung by a variety of state and local regulations that adhere to 2013 Cole Memo principles, whereby barriers to entry for company owners, managers, directors, financiers, etc. still focus on a candidate’s criminal background and/or things like residency.

Some states are also married to merit-based point systems where if an applicant lacks an eminent executive board (in, let’s say, pharma or other highly regulated industries), the applicant won’t have a shot at securing a state (or even local) license. This doesn’t allow for a lot of diversity at the executive level when it comes to experience and skillset.

Finally,  states with highly competitive licensing programs are going to amass a ton of special interest groups, and the lobbying around those groups and their goals will be business as usual: you either have a seat at the table or you’re on the menu when it comes to regulations and the industry’s future.

In the end, the overall main issue with ESG investing and cannabis is the federal conflict. Because of federal illegality, cannabis is highly regulated at the state level and those state regulations all too often focus exclusively on federal enforcement mitigation. This means states are more focused on barriers to entry that prevent criminal conduct, narrowing the number of players, and product diversion rather than on industry development, growth, and progress.

As we approach the end of federal prohibition, though (and maybe the States Reform Act can get it done!), I am very confident that many cannabis companies will fully embrace ESG concepts. These companies finally will be able to dive into ESG implementation without threat of loss licensure, regulatory sanction or consequence.

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My Cannabis Business Insurer Is Stonewalling: Can I Get Attorneys’ Fees For That? (In Washington, You Might)

Insurance issues in the cannabis space are multiplying daily as operations continue to expand across United States markets. Cannabis companies face the risk of operational losses as a result of fires, burglary, business interruptions, and myriad other events. Cannabis companies also pay hefty premiums on insurance policies to cover those very losses.

Many companies discover, however, that despite their premium payments, insurers can be particularly difficult when the time comes to pay a claim. Some companies discover that they may need to pay more in attorneys’ fees to bring their insurer into line than they may have paid for the premium on their policies. Who should bear the risk for those fees in a live dispute between an insurer and a policyholder? Washington state has decided that under some circumstances, the insurer must pay those fees.

Washington’s Insurance Fair Conduct Act (“IFCA,” RCW 48.30.010 et. seq.) provides special protections for policyholders dealing with an especially intransigent insurer. One of those protections is a statutory basis for the policyholder to seek the attorneys’ fees it incurred in pursuing it’s claim for coverage. IFCA provides that no insurer shall engage in unfair methods of competition or in unfair or deceptive acts when handling an insurance claim.

If an insurer’s denial of a claim is “unreasonable,” then the policyholder may bring an action in Washington court seeking to recover the actual damages sustained as a result of any loss (what should be covered under the insurance policy to begin with), as well as reasonable attorneys and litigation costs for having to go to court at all. This is a compelling statutory lever for any cannabis business to deal with a bad-faith coverage denial.

Moreover, IFCA identifies statutory violations that would entitle a policyholder to collect the attorneys’ fees and litigation costs it incurs when it has to sue its insurer on any particular claim. An insurer may not engage in any of the following conduct in Washington unless it is ready to pay for the costs of litigation:

  • Specific unfair claims settlement practices (defined to include misrepresentations of fact, failing to acknowledge communications from a policyholder, or refusing to pay claims without conducting a reasonable investigation, among others);
  • Misrepresentation of policy provisions (defined to include withholding information about applicable coverages, giving false deadlines, or requiring execution of a release extending beyond the subject matter of the dispute, among others;
  • Failure to acknowledge pertinent communications (defined to include failure to acknowledge receipt of notice of a claim within 10 working days (or 15 for group coverages));
  • Failure to promptly investigate a claim (requiring a complete investigation within thirty days after notification of a claim unless such time would be unreasonable); and
  • Failure to notify a policyholder whether a claim is accepted or denied within 15 working days of receipt of a fully completed and executed proof of loss.

In any of these situations, a policyholder has the right to collect the attorneys’ fees and costs it spends when it sues a stonewalling insurer. If you are experiencing difficulty communicating with your insurer or otherwise presenting a claim for coverage, a Harris Bricken coverage attorney can evaluate whether you may have a basis to collect professional fees for your representation. Having worked on both sides of this equation, our coverage attorneys know the insurer playbook inside and out, and are ready to assist with bringing your insurer into line.

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Episode 385 – A Roll of the Loaded Dice

Mike Liszewski and Kieran Ringgenberg join host Heather Sullivan to talk about the proposed States Reform Act, the ways that states handling cannabis business applications, and the latest news from marijuana social network and listing site Weed Maps. Produced by Shea Gunther.

Ketamine Clinic Acquisitions: Get the Law Right BEFORE the LOI

We often receive calls from potential ketamine clinic clients that just signed a letter of intent (“LOI”) or term sheet to acquire entire medical practices that are undertaking ketamine treatments. In the psychedelics space, many companies are starting off with off-label ketamine treatments while building towards a bigger suite of psychedelic services as the laws change at the federal and state levels (ketamine is a hallucinogen in the classical dissociative category of drugs). We’ve written many times about how hot ketamine clinics have become. See here, for example.

When potential clients sign these LOIs, they don’t even question whether or not there might be some kind of issue directly venturing with a licensed physician in the U.S. Unfortunately, in most instances, we have to break the news to the client that the proposed form of their transaction will not work under a given state’s health care laws. Among other things, the corporate practice of medicine doctrine (“CPOM”), which varies from state to state (see here, for example, in California) prohibits a layperson or lay entity from directly owning a medical practice or even employing a physician. The brain damage then ensues of what business model will work that the client can shoehorn into a deal that remotely brushes the expectations set out in the defunct LOI.

Such structuring is not a cakewalk, but not all hope is lost. In a state that has a CPOM doctrine, there are several transactional models a lay entity or lay individual can pursue–whether or not they actually make any business sense is up to the parties and their performance (like any other contract under the sun).

The Friendly PC Model

Under this model, a management services organization (“MSO”) enters into a long-term management services agreement (“MSA”) with the physician’s professional entity (“PE”). Typically, the MSO buys most of the assets (goodwill, IP, personal property, etc.) of the PE, and it also takes over the clinic lease. The MSO then helps to run the non-clinical aspects of the PE.

One bright-line rule is that the MSO cannot have any involvement in any clinical and/or medical decisions, and there can likewise be fee-splitting issues in many states (which typically arises when the PE pays excessive fees to the MSO). In most states, there are no bright-line rules for fee-splitting, but we recommend an appraisal of any fees to insulate the PE and MSO from potential fee-splitting liability.

The advantage of this model is that it is compliant with CPOM (if done correctly) and provides a constant revenue stream to the MSO. The downside for this model is that it could be hard to recapture the MSO’s investment and the MSO will not have any control over the PE outside of the MSA (which can sometimes be mitigated by non-competes, stock restrictions, and a pledge agreement with a proxy physician in place – all of which depends upon each state’s laws). We typically see MSOs paying millions (in cash and stock) for such assets (including for the goodwill and IP). In the end, unless the MSO is doing high volume work with multiple practices, it could take a while for the MSO to see any kind of return on its investment.

Minority Equity Purchase of Stock in the PE

Under this model, the MSO buys a minority interest in the PE (but, whether an MSO can buy a minority interest is completely dependent upon state law and the CPOM doctrine for each state). The advantage of this model is that the MSO can recapture its investment more quickly, and the MSO has more involvement in the management of the practice (although in jurisdictions where an MSO can acquire a minority interest in the PE, often times a majority of the managers/directors must be physicians, so the MSO will not control the day-to-day affairs of the PE).

The downside for the MSO is that it is making a substantial investment in the practice, but the MSO has no ultimate control over the entity. On the flip side, the MSO does get minority shareholder or member rights, which are potentially stronger than anything an MSA can provide.

While there may be some creative ways to give the MSO more control (e.g., mandating that certain decisions will require the unanimous consent of the owners and/or directors/managers), there is simply no way for an MSO to essentially control all decisions for the practice. Moreover, as a minority owner, the MSO has more exposure to medical malpractice claims. While the MSO would not necessarily have primary liability (since it is not practicing medicine), the practice would, and that would directly impact the MSO’s investment (if, for example, an award exceeded the malpractice insurance coverage amounts). We rarely see our ketamine clinic clients directly venture with physicians in this way.

Hybrid Model

If an MSO combines the Minority Equity Purchase Model with the Friendly PC Model, you get closer to the best of all worlds with less exposure on the liability side. The MSO can recapture its investment much faster and the MSO would have as much control as possible since it would be running the MSO independently from the practice.

Joint Ventures

One way to entice a physician to pursue one of these models (when he or she cannot sell their practice outright) is to incorporate a joint venture agreement (“JV”). JVs in healthcare can get very tricky if there is federal or state reimbursement involved. There have been several fraud warnings issued by the main US regulator for healthcare fraud and abuse issues. For more details on ketamine clinics and JVs, see here.

If, however, the practice is all cash pay (or no federal or state money – and possibly no commercial insurance as well), then a JV gets easier. Under this model, the physician could enjoy some of the profits from the JV without having to invest in the JV (but that is obviously a business decision for the MSO to make). One of our clients (an MSO) is currently pursuing a JV and it is fronting 100% of the costs of each new clinic but giving a 50% ownership interest to the practice (for their time and effort in setting up these new clinics).

However, before a JV can be finalized, state law must also be reviewed to make sure there is nothing that would prevent the JV. For example, if a state has a referral prohibition for physicians (which is akin to the Stark law at the federal level), then the MSO would need to make sure the structure is feasible.

Side Note for Insurance

Third-party reimbursement (insurance) is a tricky thing. The upside for taking insurance is that it drives volume for a clinic. The downside is that commercial and government insurers typically try to squeeze physicians on reimbursement, they can be difficult to deal with (and get claims paid), and there are some federal fraud and abuse laws that apply to commercial insurance. We believe that the typical intravenous ketamine treatment is probably not reimbursable by Medicare and Medicaid, but we have seen clients VA cover some services, like intravenous ketamine (additionally, Esketamine may have some coverage since it’s being used for “on label” claims – or at least some of the time).

If an MSO intends to pursue other psychedelics if and when they are approved by the Food and Drug Administration, it is possible that there will be more insurance coverage available. Since several psychedelics are going through clinical trials, they could be used for “on label” claims which have a higher probability of third-party reimbursement. Formularies and coverage decisions for insurers are complex issues that are usually dealt with on an insurer-by-insurer basis.

At the end of the day, health care is full of traps and landmines for the uninitiated (both for clients and your run-of-the-mill corporate and transactional attorneys). We highly recommend that clients vet deals with health care attorneys before signing LOIs and term sheets. Not only does it set realistic expectations for both parties when a deal is coming together, but it also saves the client time and money overall.

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Here’s How MDMA Will be Regulated

Cannabis is legal and regulated in most U.S. states. Oregon legalized and will soon regulate psilocybin. Cities around the country decriminalized (and more are decriminalizing) a host of other psychedelics. Ketamine clinics are popping up around the county. Next up is MDMA (referred to in some forms as “ecstasy”). Today, we’re going to talk about how MDMA will be regulated.

In 2019, when Denver opened up the psychedelics floodgates by legalizing psilocybin, it was totally unclear what the future of regulated psychedelics will look like. With a few exceptions, that’s still the case. It’s entirely plausible that they go the route of cannabis (as is happening in Oregon) or some new route (as is happening with local grassroots decrim efforts). But the point is we really have no idea how that will all shake out in the long run.

That’s not the case at all with MDMA, and we can predict its future with a much greater degree of certainty. The reason for this is because MDMA is winding its way through the U.S. Food and Drug Administration’s (FDA) process for Investigational New Drugs (IND). For a really good and succicnt summary of that process, you should read my colleague, Ethan Minkin’s, summary here.

The entity behind MDMA’s push through the IND process is the Multidisciplinary Association for Psychedelic Studies (MAPS). While a few years ago, the concept of legal MDMA may have seemed crazy to some, MAPS has done a masterful job cutting through the red tape. Earlier this year, we wrote about how MAPS was progressing through the Phase III study process and was targeting FDA approval in 2022 and commercialization in 2023 — if these targets are met, they would be on par with Oregon’s legal psilocybin licensing program.

With that all in mind, let’s return to what the regulated market will look like. Assuming MDMA is approved to treat certain conditions — and in our view, this is a “when”, not an “if” — it will be another regulated drug that can be administered by physicians in certain conditions. It will, to be sure, be subject to greater degrees of regulation than, say, ibuprofen, but you get the picture.

To see just what regulated MDMA will be like, we need to look no further than the regulated ketamine industry, something our lawyers have a lot of experience guiding clients on. Ketamine is a Schedule III narcotic and we did a really solid summary on how it is regulated here. In short, physicians prescribe and administer it for certain approved indications, need to register with the DEA, need to follow strict security and reporting protocols, and much more. Also, businesses intending to get into the industry need to be mindful of a massive amount of state and federal regulations, including things like restrictions on who can own a clinic and the relationships between physician-owned clinics and management services organizations.

In all likelihood, FDA-approved MDMA would be prescribed and administered in very similar conditions. And while MAPS is seeking approval for MDMA for post-traumatic stress disorder, physicians will almost certainly prescribe and administer it for off-label uses.

2023 may seem like a ways away at the moment, but it may not be long until there is an actual regulated market for MDMA. Healthcare laws are extremely complicated, but the upside is that unlike with cannabis and psychedelics, there’s a pretty clear roadmap for how things will likely shake out. We will continue to keep you all updated on MAPS’ progress, so please stay tuned.

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Trademark Litigation: Happi Hour is Over

We’ve seen a steady stream of trademark litigation in the cannabis space for quite some time now, and it’s as good a time as any to remind our readers that parody is not a defense to trademark infringement.

In its complaint filed Monday, Plaintiffs Big Beverage, Inc. and Happy Hour Drinks Company, Inc. dba Happy Hour, two companies based in Los Angeles, allege that Defendant Happi Co. infringed their three registered trademarks when it began selling its cannabis-infused fruit flavored sparkling water bearing a “IT’S HAPPI HOUR” label. Big Beverage owns three registered trademarks for wine, distilled spirits, and beer. Plaintiffs note their various products also read HAPPY HOUR on their products, and that they’ve used those marks since 2013.

Plaintiffs allege that in August 2021, Happy Hour’s co-packing partner alerted them to the infringing conduct. Plaintiffs investigated, and found that Defendant had obtained rights to the domain name in February 2021. While it seemed like Happi intended to respond after receiving Plaintiffs’ initial demand letter, it has failed to substantively respond for over one month now.

The complaint demands injunctive relief restraining Defendant from selling the infringing products, an award of all Defendant’s profits from the sales of the infringing products, an award of Plaintiffs’ attorneys’ fees and costs, and such other proper relief.

We’ve made this point many times before, but it bears repeating: cannabis companies are not immune from trademark infringement claims, and it’s of utmost importance that proper research is done before branding – not only to make sure that infringement of cannabis industry players isn’t happening, but infringement of players outside of the cannabis world. As a reminder, the factors a court will consider in assessing whether one mark is likely to be confused with another, proving trademark infringement (AMF Inc. v. Sleekcraft Boats):

  • Strength of the mark;
  • Proximity of the goods;
  • Similarity of the marks;
  • Evidence of actual confusion;
  • Marketing channels used;
  • Type of goods and degree of care likely to be exercised by the purchaser;
  • Defendant’s intent in selecting the mark; and
  • Likelihood of expansion of the product lines.

The two most basic factors we recommend our cannabis clients evaluate are: (1) is your mark similar to or the same as an existing mark, and (2) are you intentionally “riffing” off an existing brand? As we’ve said before, parody is not a defense to trademark infringement. When you choose a mark as a “parody” of an existing brand, it’s very possible that you’re actually infringing a registered trademark, and possibly diluting a famous mark. And if it’s established that you knew of the senior trademark, that’ll open the door for even greater damages because your conduct would be deemed willful.

These factors are only the beginning of the analysis. The bottom line is, do your research, and consult with experienced trademark attorneys that can perform a clearance search and work with you on your branding strategy. It’ll be worth it in the long run.

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BREAKING: Germany to Legalize Adult-Use Cannabis

On November 18, 2021, local media sources confirmed that members of Germany’s incoming governing coalition (comprised of the Social Democratic Party of Germany (SPD), the Free Democratic Party (FDP), and the Greens) intend to introduce legislation to legalize adult-use cannabis in Germany.

Germany stands to become the next of shockingly few countries that have approved full legalization of adult-use cannabis, joining Canada and Uruguay (and a number of US states. Germany would become only the second G-7 nation to legalize adult-use cannabis and the first on the European continent to do so. As noted in this Prohibition Partners article, the Netherlands and Switzerland are also set to introduce adult-use cannabis legislation on a trial basis in 2022.

What will the adult-use cannabis industry look like in Germany? From a coalition spokesperson:

We’re introducing the controlled distribution of cannabis to adults for consumption in licensed stores. This will control the quality, prevent the transfer of contaminated substances and guarantee the protection of minors. We will evaluate the law after four years for social impact.

The societal benefits of adult-use legalization in Germany are obvious (and similar to those in the US): an estimated €4.7 billion benefit to the German economy, which includes the cost savings of cannabis-related criminal enforcement and incarceration as well as generated taxes.

As is the case every time broad adult-use cannabis legalization is announced, the devil is in the details. We will need to see the actual text of the legalization, any rules and regulations that will govern licensure and operation, and timeframes for implementing said rules and regulations, before really being able to evaluate the potential business opportunities for entrants into Germany’s prospective adult-use cannabis industry.

Still, any time national adult-use cannabis legalization is announced, let alone in a country as significant as Germany, it’s a big deal. We will provide a summary of the proposed legislation and keep you apprised of any developments as Germany moves towards legalized adult-use cannabis. Stay tuned!

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Breaking News – Lawsuit Filed to Enjoin Arizona’s Social Equity Program Regulations

On November 18, 2021, the Greater Phoenix Urban League and Acre 41 Enterprises, LLC (the “Plaintiffs”), sued the State of Arizona, the Arizona Department of Health Services (the “Department”), Governor Ducey, and the Director of the Department for their purported failure to implement the social equity provisions of Proposition 207 by issuing final regulations that undermine the will of Arizona voters. Under Proposition 207, which was passed by the voters in Arizona in November 2020, it is now legal for license holders to sell marijuana for recreational purposes.

Moreover, as part of the proposition, the following was passed which created Arizona’s SEOP – the Department will pass rules for the creation and implementation of a social equity ownership program to promote the ownership and operation of marijuana establishments and marijuana testing facilities by individuals from communities disproportionately impacted by the enforcement of previous marijuana laws. ARS § 36-2854(A)(9). In October 2021, the Department released the final regulations for the SEOP after issuing several draft regulations. The final regulations became effective on November 17, 2021. Many individuals and companies commented on the proposed regulations.

The Department was scheduled to start receiving applications in December 2021, but now that seems to be in a state of flux due to the new lawsuit. The application period was supposed to run from December 1 to December 14, 2021. Whether the Department will accept applications during that time period is now in the hands of the court.

According to the press release issued by the Plaintiffs:

The lawsuit demands compliance with the intent of Proposition 207—the 2020 voter initiative that made recreational marijuana legal in Arizona and requires the State to issue 26 valuable marijuana dispensary licenses to individuals from “communities disproportionately impacted by the enforcement of prior marijuana laws.” The regulations proposed by the State undermine the will of Arizona’s voters by failing to ensure those 26 licenses will remain in the hands of individuals from disproportionately impacted communities after they’re issued by the Arizona Department of Health Services. As it stands now, the regulations proposed by the State do not prohibit venture capital firms and large, mostly white-owned, multi-state marijuana companies from snatching up all social equity licenses from the 26 successful applicants—effectively defeating the purpose of the voter-approved social equity program.

Moreover, the Plaintiffs also contend:

Most concerning to the Greater Phoenix Urban League, the regulations fail to ensure the 26 social equity dispensaries will be operated in a way that benefits communities most harmed by the “War on Drugs.” The lawsuit challenges the State’s failure to implement rules to establish a program for the operation and oversight of 26 social equity licenses and its failure to formulate rules that ensure the social equity dispensaries and related businesses are operated by individuals from communities the law was intended to help.

Since the lawsuit was just filed, it is premature to know whether the court will issue any kind of injunction or otherwise grant the relief requested in the complaint. The complaint goes into greater detail about the various ways the regulations purportedly violate the spirit and intent of the SEOP.

We will continue to provide updates as this litigation progresses.

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Cannabis Securities Litigation: SDNY Dismisses Fraud Case Arising from Canadian IPO

One of the cannabis litigation trends we discussed in a recent webinar was the increasing number of lawsuits alleging some type of fraud by cannabis companies during the capital-raise phase of their businesses.  For most businesspeople, raising capital to fund their new business is essential. Just as essential is making sure that you comply with federal and state securities laws. We’ve been writing about the intersection of these issues for several years.

Perhaps the most critical thing for cannabis entrepreneurs to know is that federal law and state counterparts define the term “security” quite broadly. So broadly that nearly any method of raising capital for a business venture falls under the rubric of offering a security that is subject to stringent rules and regulations. As Jonathan Bench helpfully summarizes, “[i]n the cannabis industry, a ‘security’ is any type of financial interest in any business venture for any amount over any period of time, even if that business is not a formally registered company.”

This blog post discusses a recent decision by the Southern District of New York dismissing a securities fraud lawsuit filed against a Canadian company that sought to raise money as part of an international hemp-CBD business plan and strategy. The case is SUN, A Series of E Squared Inv. Fund, LLC v. Sundial Growers Inc., No. 1:20-CV-03579 (ALC), (S.D.N.Y. Sept. 30, 2021).


The lawsuit demonstrates the global nature of the cannabis industry. (Something our international and trade and customs lawyers can confirm.) Plaintiffs were comprised of an investment fund based in New York, a hedge fund based in Israel, and other companies based across the United States. Defendant was a licensed producer of cannabis based in Canada.

(The background here is from the allegations in the complaint)

After the legalization of cannabis in Canada in 2018, Defendant sought to raise US$50 million prior to its initial public offering (“IPO”) to fund the acquisition of another company (the “Target Company”). Plaintiffs met with Defendant in early 2019 in Toronto where Defendant presented information that the Target Company had a hemp license allowing the cultivation, processing, and export of finished product to the United Kingdom. The Target Company allegedly would provide scalable growth for only C$20 million in capital expenditures and would generate C$256 million in revenue and C$115 million of EBITDA in 2020.

Not long after the meeting in Toronto, Defendant released an investor presentation indicating Defendant sought to raise C$70 million to fund the Target Company acquisition. The investor presentation highlighted that the fully operational Target Company would allow Defendant to be “the first mover in mass-scale, global hemp-derived CBD products” and that the Target Company had a hemp license. The investor presentation stated that the offering would be in the form of convertible unsecured promissory notes wherein the holder would have the option to convert the notes into common shares upon a qualifying IPO at a discount depending on when the IPO occurred. (This is the “security” at issue).

Plaintiffs agreed to invest $7 million in the pre-IPO round.

In July 2019, Defendant filed a Registration Statement on Form F-1 with the SEC. (Side note: Form F-1 is the standard registration statement filed with the SEC by foreign private issuers of securities and by private foreign companies seeking to go public and be listed on a U.S. Stock Exchange). The Registration Statement was amended twice in later July and the Risk Factors stated that the Target Company currently held a company cultivation license through December 31, 2021 and that Defendant would renewal of the license with the United Kingdom Home Office prior to expiration. Defendant warned that the ability to recognize the strategic objective of their acquisition of the Target Company could be materially adversely affected if the Home Office delayed or did not renew the license.

In August 2019, Defendant filed its Prospectus with the SEC, pursuant to which Defendants made its IPO of common stock. Defendant offered 11 million shares of common stock at an initial price of $13.00 per share. Defendant raised US$134.4 million and Plaintiffs converted their notes into shares at a price of C$13.84 per share.

After the IPO, Defendant held an investor call in which one of the placement agents stated “I know that there’s a couple of licenses you’re waiting for before you can start really converting and growing hemp at [the Target Company’s] facilities.” Later, a research analyst for the same placement agent stated the Target Company “requires key licenses and we expect there will be a natural ramp and learning curve associated with the conversion of [the Target Company’s] greenhouses from growing herbs and ornamental flowers to growing hemp.” The analyst estimated revenues of C$98 million on 2020 and C$243 million in 2021.

(Side note: A “placement agent” is a registered broker-dealer that assists a company in structuring its capital raise and acts as a sort of intermediary between the company and prospective investors)

On August 16, 2019, Defendant’s stock opened at $10.54 per shared. By the end of the month it had declined approximately 25%.

Plaintiffs alleged that the placement agent visited the Target Company in October 2019 and discovered the company was only growing hemp in a limited capacity under a license that did not allow the hemp to be sold or the flowers to be extracted into CBD. The placement agent reported the Target Company had applied for a  license to permit the extraction of and that there was “no indication as to if, or when” the Target Company would receive the necessary licenses.

In November 2019, Defendant held an earnings call where it stated it was working with the UK Home Office to secure the necessary licenses and that it anticipated obtaining the licenses by year end.

In its fourth-quarter earnings call, Defendant reported a net loss of C$145.1 million due primarily from the acquisition of the Target Company.

Plaintiffs allege that the Defendant’s accountants determined that the goodwill attributed to the purchase price of the Target Company was “grossly inflated” and that the Target Company’s ability to generate cash flows deteriorated such that the fair value of the goodwill fell below its book value.

In early February 2020, Defendant announced that key members of its management team were leaving he company.

Defendant’s stock dropped 50%—corresponding a market cap drop to roughly $133 million—an 87% decline from the IPO valuation.

In March 2020, Defendant announced its intent to sell the Target Company. In April 2020, Defendant’s sock closed at US$0.50 per share—more than 95% below its $13.00 original list price.

The Alleged Securities Fraud

Plaintiffs filed suit in May 2020 and an amended complaint in January 2021. Plaintiffs alleged that Defendant made “false statements of material facts and concealed/omitted material facts regarding [the Target Company’s] capabilities, specifically, that Bridge Farm had the requisite licenses to “cultivate, process and export” hemp and CBD from the UK.” Plaintiffs also alleged Defendant knew or should have known the Target Company did not have the requisite licenses to cultivate, process, and export hemp and CBD and, therefore, knew or should have known the acquisition would not result in the projected 2020 revenues and growth.

Plaintiffs contended that the individual defendants (former executives of Defendant) were focused on maximizing their individual holdings by completing the IPO quickly and believing the acquisition of the Target Company would make the IPO more successful.

Plaintiffs pleaded that Defendants committed securities fraud in violation of Section 10(b) of the Securities Exchange Act of 1934, SEC Rule 10(b)-5, and Sections 12(a)(2) and 15 of the Securities Act of 1933 along with common law claims for breach of contract, fraud in the inducement, and negligent misrepresentation.

Defendants moved to dismiss the Complaint for failure to state a claim.

Heightened Pleading Standard: The Private Securities Litigation Reform Act of 1995 (“PLRSA”)

When a plaintiff alleges fraud—whether under common law or Section 10(b) of the Exchange Act—a “heightened” pleading standard applies under the federal rules and the PLRSA. This means a complaint must state “detail the statements (or omissions) that the plaintiff contends are fraudulent, (2) identify the speaker, (3) state where and when the statements (or omissions) were made, and (4) explain why the statements (or omissions) are fraudulent.”

The PLRSA applies an even more stringent standard. A plaintiff “must (1) specify each statement alleged to have been misleading and the reason or reasons why the statement is misleading and (2) state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.”

So pleading claim of securities fraud is no simple matter.

Federal Rules the Plaintiffs Did Not Allege a Material Misrepresentation or Omission

A violation of 10(b) and Rule 10b-5 cannot occur unless an alleged misstatement was false at the time it was made. This means a statement believed to be true, but later shown to be false, is not actionable. This proved fatal to the plaintiffs’ claims.

Here the plaintiffs alleged several misstatements in the investor presentation constituted securities fraud. But none were sufficiently pleaded to be false or misleading “at the time made.” More specifically, plaintiffs did not sufficiently plead that defendants did not believe (at the time) they made representations that the hemp license in place allowed for cultivation, processing, and exportation of finished product from the UK or that it would allow them produce and distribute at a scale more quickly than competitors. Other statements were insufficient to constitute actionable securities fraud because they were forward-looking statements – e.g. projections of revenue and plans and objectives for management of future operations and of future economic performance.  Moreover these forward-looking statements were accompanied by cautionary language along the lines of “actual results could materially differ from those anticipated” because of a number of factors and risks.

Federal Rules the Plaintiff Did Not Adequately Allege Scienter (Knowledge)

When examining whether a plaintiff adequately alleged the prong of a claim, courts examine all of the pleaded facts collectively to decide whether those facts “give rise to strong inference” of scienter. Here, said the court, the plaintiffs conclusorily alleged that defendants “knew or should have known” that the Target Company did not possess the required license. Plaintiffs also alleged a motive of personal profit. But plaintiffs did not allege that defendants benefited in a concrete and personal way from the alleged fraud—such as through the sale of shares. And plaintiffs did not allege that defendants deliberately engaged in illegal behavior or had access to information suggesting their statements were false.

Finally the court dismissed claims brought under Section 12(a)(2) and Section 15. The case is instructive for investors who believe they were misled into cannabis and instructive to companies raising money. Even though the case was dismissed, I am sure it cost the defendants a small fortune to defend.

For more on cannabis securities, see:

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