Written by Tammy A. Brown, Esq., Chair, Wendel Rosen LLP Employment Practice Group

This blog post provides some general guidance on employment issues that many California businesses are facing related to employment in light of the COVID-19 crisis, including the new federal laws on paid sick leave and paid family leave for taking care of children. As you consider the challenges and response strategies discussed in greater detail below, please know that Wendel Rosen is available to advise and answer the specific questions that you may have.

Staying Open / Essential Businesses

Essential Businesses

Essential businesses can stay open. See attached summary of essential businesses under California’s shelter-in-place executive order.

(a) Protecting Employees

Once a business determines that it can operate as “normal“ because it is essential, it should be aware of a few additional factors. The first obviously is to take reasonable steps to protect its employees from the virus, and thus protect against claims of negligence.  This means assessing how the business is vulnerable to exposure to and/or spread of the virus. This would likely include methods of performing job duties while maintaining social distancing, providing protective gear, and some kind of training. The latter may just be a talk or memo with some common sense pointers and reiterating what the CDC and State has said.

(b) New Federal Laws for Sick Leave, etc.

Employers with less than 500 employees will be subject to the federal laws providing for paid sick leave and emergency family medical leave.   Beginning April 2, 2020, employers with less than 500 employees will be required to provide paid sick leave and paid “FMLA” for circumstances related to the COVID-19 outbreak.   The emergency FMLA is for employees who are unable to work, including telecommuting, because their minor child’s school/daycare has closed because of the virus.   For more details, see section C below.

Non-Essential Businesses

Non-essential businesses can operate, but in different formats. This may mean office workers telecommuting, restaurants providing only take-out meals, and bars being allowed to sell bottles of alcohol on a pick-up basis.

(a) Issues for Employers with Employees Working at Home

Having employees work at home raises a number of issues for employers, especially if they do not have telecommuting policies in place. Briefly:

• • • Non-Exempt employees should be reminded to take their rest and meal breaks. It would be good to have the employees report on a daily basis their time (including clocking out for meal breaks) and confirming they took their rest breaks.
    • Employees should be reimbursed for expenses associated with requirements for working from home, such as internet costs and phone. It is common to reimburse employees $50-$75/month for these expenses.
    • Workers comp – injuries incurred on the job while working at home should be reported immediately as they are still subject to workers comp.
    • Protect confidential and proprietary information.
    • If an employee refuses to work from home for a reason that is not protected by law (e.g., telecommuting does not work with their reasonable accommodation), then the employee can be furloughed or terminated, though the employer should consult with legal counsel.

(b) Federally Mandate Sick Leave and Leave Associate with Child Care

Employers with less than 500 employees will be subject to the federal laws providing for paid sick leave and emergency family medical leave. See section C below.

LAY-OFFS AND TERMINATIONS

Many employers are laying off or terminating employees or reducing their hours. Issues to keep in mind:

Last Day Issues

If employees are terminated or laid-off for an indefinite amount of time, then the employer must pay the employee on their last day of employment all amounts owed to the employees (just like before).  This includes hours worked to date, premiums for missed meal and rest breaks, unused vacation/PTO, and reimbursement for expenses.  Sick leave, whether provided by state or federal law or the employer, is not a wage and therefore is not paid out at termination.  There are different rules applying to employees who earn commissions based on future events.

If employees are laid off with a definite return-to-work date (furloughed), they are to be paid regularly and do not need to be paid unused vacation/PTO.  The return to work date should be reasonable; if it is too far into the future, the Labor Commissioner will consider it a termination for final pay purposes.  There is no set rule for what is reasonable.

Mass Layoffs

Employers may be subject to state or federal WARN Act requirements for mass layoffs.  California has suspended the penalties associated with not complying with the state’s WARN Act, but it has not suspended the requirements relating to notice to employees and local authorities.  See section D below.  The notices and triggering events can be complicated and employers should consult with their attorneys.

Unemployment Benefits

Unemployment is available immediately to employees who are let go during the crisis (no one-week waiting period).  The weekly benefit amount is about 60-70 % of wages earned in the prior 5 to 18 months, up to a maximum of $1300.

Also, full-time employees who lose income because of reduced hours may be eligible for unemployment benefits even if they are still working.  These are called “partial benefits” by California’s EDD.  Partial benefits occur in two circumstances for full-time employees:

• • Who are laid off for no more than two consecutive weeks, OR
  • Whose gross earnings, when reduced by $25 or 25 percent, whichever is greater, are less than their weekly benefit amount.

A full-time employee is eligible for partial unemployment under the following conditions:

• • The employee becomes partially unemployed through no fault of his/her own; and
  • The employee works less than normal full-time hours because of lack of work; and
  • The employee’s normal weekly earnings are reduced by lack of work; and
  • The employee’s gross earnings, after deducting the first $25 or 25 percent of the total earnings (whichever is greater), are less than his/her weekly Unemployment Insurance benefit amount.

NEW SICK LEAVE / CHILD CARE LAWS

On March 18, 2020, President Trump signed House Bill 6201, the Families First Coronavirus Response Act (“FFCRA”). The law takes effect on April 2, 2020, and remains in effect until December 31, 2020. The FFCRA amends portions of the FMLA and also provides for paid sick leave in certain circumstances related to the current COVID-19 pandemic.  It applies to employers with less than 500 employees.

Employers will be “reimbursed” for these paid wages by a credit against the tax employer’s pay roll taxes for each calendar quarter in an amount equal to 100 percent of the qualified sick leave wages paid by the employer.

The Federal government will be preparing guidelines for employers, but, at the time of writing, no further guidelines have been issued.

Federal Sick Leave Law

Amount:  It provides for 10 days of sick leave to be paid by employers.

Employee Qualifications:  Paid sick leave is available for immediate use, regardless of how long an employee has been employed.

Reason for Sick Leave:

Self-care:  Employee is sick due to COVID-19 OR employee is quarantined due to COVID-19 (quarantine can be imposed by government or by the employee’s medical provider) OR the employee is experiencing symptoms of COVID–19 and is seeking a medical diagnosis.

Care of Others:  Sick leave is also available for employees caring for someone who is experiencing symptoms of COVID–19 and who is seeking a medical diagnosis OR the employee is caring for a minor child whose school or day care provider is unavailable because of COVID-19.

Pay:  For full-time employees, it is 80 hours; part-time employees receive the number of hours that the employee works on average in a two-week period.

Employees are paid at their regular rate of pay as determined by the federal Fair Labor Standards Act (FLSA) or at the minimum wage, whichever is greater, for uses associated with the employee (i.e., self-care or quarantine). Employees are paid at 2/3 of their regular rate of pay for uses related to care of another, including childcare.

Paid leave is capped at $511 per day and $5,110 in the aggregate for self-care or quarantine and is capped at $200 per day and $2,000 in the aggregate for care of another.

An employee may use paid sick leave under this law before using other leave, but cannot be required to.

Federal Emergency Family Medical Leave – Child Care

The new law provides for 12 weeks of leave related to having to care for a minor child because of school closure or unavailability of child care related to COVID-19.  The first two weeks are not paid by the employer (though the employee can take the sick leave described above), whereas the remaining 10 weeks are paid at 2/3 the employee’s salary, subject to caps.        

Employee Qualifications:  Employees must have been employed by the employer for 30 days or more prior to the requested leave.

Reason for Emergency FMLA Leave:  The leave is only for employees who are unable to work, or unable to telework, due to a need to care for a minor child if the child’s school or place of care has been closed or the child care provider is unavailable due to a public health emergency related to COVID-19.

This leave does not apply to employees who are not permitted to come to work because of a shelter-in-place order but are unable to work from home for some reason (such as they do not have internet or no phone).

Pay:  Employers must provide paid leave for each day of emergency leave taken after the initial 10 days, in an amount not less than two-thirds of an employee’s regular rate of pay, with caps at $200 per day and $10,000 total.

Employees may elect to substitute any accrued paid vacation, parental, medical or sick leave for unpaid leave; employers cannot force them to use this time.

Exceptions:  Employers with less than 50 employees if compliance would jeopardize the viability of the business as an on-going concern.  Also, certain healthcare providers and emergency responders are exempt.

Job Protection:  Like “regular” FMLA, the new law provides for job protection of employees using it.  There is a limited exception for employers of less than 25 employees where the employee’s position no longer exists upon return to work due to economic conditions or other changes caused by the coronavirus emergency, and the employer has made reasonable efforts to restore the employee to an equivalent position.

“Regular” FMLA is still available pursuant to its own terms.

LAYOFF ISSUES – WARN ACTs

California and the federal government have WARN Acts (Worker Adjustment and Retraining Notification) that require notices be given to employees and certain government agencies.  The California act applies in specific circumstances to employers with 75 or more employees.  If the employer has 100 or more employees, they must also comply with the federal WARN Act.  Employers should consult with an attorney because there are a lot variables.  Below is a general summary.

California WARN

Triggering event under California law:  Layoff of 50 or more employees during any 30-day period regardless of percentage of work force.

The California WARN Act requires employers to provide 60 days’ advance notice when they conduct a mass layoff, relocation, or termination. Usually, failure to provide 60 days’ notice can result in severe liability – up to 60 days of back pay plus benefits for all laid-off, relocated, or terminated employees, in addition to civil penalties.

On March 17, 2020, Governor Newsom suspended the provisions of California’s WARN act that impose liability and penalties. His executive order waives the 60-day notice requirement for the duration of the COVID-19 emergency. The order applies where COVID-19-related business considerations result in mass layoffs, relocations, or terminations that were not reasonably foreseeable as of the time that notice would have been required.

To qualify for the waiver of the 60-day notice requirement under the order, employers must:

1. give written notice to employees; the EDD, the local workforce investment board, and the chief elected official of the local city and county government;
2. give as much notice as is “practicable,” along with a brief statement of the basis for reducing the 60-day notification period;

for written notice given after March 17, 2020, include the following statement: “If you have lost your job or been laid off temporarily, you may be eligible for Unemployment Insurance (UI). More information on UI and other resources available for workers is available at labor.ca.gov/coronavirus2019.”

Federal WARN Act

The federal WARN act applies to employers of 100 or more and is still in effect, though it contains an exception for “unforeseeable circumstances.” Triggering events vary, but include plant closures , permanent or temporary shutdown of a single site of employment or facility (or operating unit within a single site of employment) that involves 50 or more employees during a 30-day period if the number of affected employees is at least 33% of the workforce.

Notice requirements are much the same as California’s.  In either case, attorneys should be consulted.

Co-written by Karen Balderama, Wendel Rosen LLP Business Practice Group Co-Chair and Mia Butera, Wendel Rosen LLP Business Attorney

The COVID-19 pandemic will have lasting unknown effects on businesses and has already caused delays and cancellations with respect to fundraising efforts and investment transactions planned or already in progress. Although raising capital during a pandemic seems like an impossible task, there are investors and issuers that are carefully progressing through the process of pitching, conducting due diligence, negotiating terms, and even closing rounds of financing. Issuers and investors fortunate enough to move forward on their transactions will have some additional considerations to mull over as they negotiate terms and determine an appropriate valuation for a company at a time when the global economy appears to be on the brink of collapse.

This post will discuss the need for companies thinking about fundraising in a private offering of securities to make additional disclosures to prospective investors regarding the impact of the COVID-19 pandemic.

For non-reporting companies conducting a private offering of their securities to investors, disclosures about how the COVID-19 pandemic has and will continue to impact the issuer should be made in a private placement memorandum (PPM). A PPM is the primary disclosure document provided to prospective investors in private offerings of securities to help investors make an informed decision regarding whether to invest in a particular business. Generally, a PPM will provide information about the issuer, the securities to be issued, the issuer’s business, operations, and the advantages, disadvantages, and most importantly, the risks associated with the issuer and thereby the securities the investors intend to purchase. The COVID-19 pandemic will have a material adverse effect on the global economy and on many businesses. A failure to disclose or adequately describe the investment risk it poses may be a material omission or misstatement that could allow investors to have claims for damages or even rescind their investments.

Not all issuers will be affected equally by the COVID-19 pandemic. For many businesses, the impact of the pandemic will be far reaching and substantial, but it may not be material for others. This is why the risk factors disclosed in PPMs should be specifically tailored to address the issuer’s own unique, or not so unique, set of circumstances. Issuers and investors alike will be confronted with challenges caused by disruptions in the consumer marketplace, government regulations and restrictions in response to the pandemic, and other unknown changes in federal and state law. Disclosures should be made around the significant uncertainties regarding the effect of the COVID-19 pandemic on different aspects of the issuer’s business, such as labor and employment matters, supply chains, distribution and customer demand, and the short and long-term negative impact on the issuer’s operations, financial condition and projections.

Labor and Employment

In addition to the usual risk factors around hiring employees and/or independent contractors such as workers’ compensation, wage and hour compliance, availability of highly skilled workers, immigration laws, harassment claims, and management issues, the COVID-19 pandemic will likely have a major impact on hiring, retaining, paying, and managing workers. Shelter in place orders mean that non-essential businesses are forced to operate almost entirely remotely which will prove challenging for even the most tech-savvy and remote-friendly companies. Essential businesses that still operate during the pandemic must put into place and enforce social distancing policies, and may have additional liability if an employee contracts the virus at the workplace.

Supply Chain

The COVID-19 pandemic will likely have some sort of impact on an issuer’s supply chain. This might be in the form of delays in shipments of supplies, key vendors temporarily ceasing operations, service providers unable to perform their duties in a timely fashion, or distributors and sales teams unable to sell and market the issuer’s products. This could or may already have a negative effect on the issuer’s financial condition.

Closures for Non-Essential Businesses

It will be important to determine if the issuer is deemed an “essential business” in the jurisdictions in which it operates. Whether it is or not should be disclosed. Additionally, an issuer should have a general plan for how operations will continue during and after the pandemic. For businesses that are non-essential and require on-site activities (manufacturing, in-person service providers, etc.) it may prove impossible to carry on operations as normal and there are unknown risks and restrictions for future operations.

Demand and Market Downturn

The COVID-19 pandemic will likely have an adverse effect on the global economy as a whole, resulting in an economic downturn that could impact demand for the issuer’s products or services. Likewise, issuers should let investors know if they are in a position to take advantage of closures or other impacts of the pandemic, for example businesses offering medical supplies, remote collaboration technologies, or delivery services may see an uptick in demand and revenue.

Government Response

Federal, state and local governmental authorities have passed legislation and issued rules and executive orders aimed at blunting the economic impact of lockdowns and shelter in place orders to workers and businesses alike. The costs of such measures such as mandated paid sick leave may be borne solely or partially by businesses, which may have a material adverse effect on their financial condition. Uncertainty around how long the pandemic will last and its continuing effects on the economy may result in further government actions that could adversely impact the business and financial prospects of the issuer. Issuers are advised to monitor new legislation or orders to which they may be subject and assess how such government actions may impact their business. If the issuer’s business will be or might be materially affected, appropriate disclosures to investors should be made.

An issuer may either (1) revise or update its existing risk factor disclosures in its offering materials to address how each area has been or may be affected by the COVID-19 pandemic, or (2) include a new standalone risk factor disclosure regarding the COVID-19 pandemic and its impact on the issuer’s overall business. Either way, it is important to be fully transparent about the pandemic’s effect on the business of the issuer. Because of the rapidly changing nature of the pandemic and government and societal reactions, it is important that an issuer monitor these developments and their impact on its business and update its disclosures as circumstances change.

Issuers or investors with questions regarding COVID-19 risk factor disclosures may contact any member of Wendel Rosen’s Business Practice Group.

The California hemp industry received welcome news this week when the U.S. Department of Agriculture released its much-anticipated interim final rule for hemp production, a critical step toward implementing the 2018 Federal Farm Bill and a key for states wanting to regulate their own hemp markets.

The USDA Hemp interim final rule (interim rule) is 160 pages and, in contrast to its singular name, includes scores of hemp rules, including  clarifying states’ required practices for record keeping, methods for testing hemp to ensure that it is below the legal THC limit, and plans for the proper disposal of non-compliant hemp. In addition, the interim rule makes it clear that states and Native American tribes may not prohibit the interstate transport of hemp that has been legally grown under federal and state law. The interim rule was expected to become effective this week upon publication in the Federal Register.

The Farm Bill removed industrial hemp (cannabis with trace amounts of THC) from the Controlled Substances Act more than a year ago, but the crop, its producers, states, and local governments have operated in a murky legal territory absent a federal framework. Based on the Farm Bill, states desiring to legalize hemp production and control their own regulatory schemes must submit a conformance plan to the U.S. Department of Agriculture (USDA).

Until the release of the interim rule, this created a Catch-22, because states struggled to draft federally-compliant plans not knowing exactly what the USDA wanted to see. In California, the absence of a state plan has meant that approximately half of the state’s counties have imposed temporary bans or restrictions on hemp cultivation while awaiting further direction from the state and federal government.

With the interim rule’s publication, states can now complete their hemp plans with confidence that the plans are federally compliant. While the final interim rule is not “final” (it actually will sunset in two years) and is subject to public comment in the coming months, it provides states with a degree of certainty. California is said to now be working on its hemp compliance plan and a bill recently signed by Governor Gavin Newsom (see our prior blog regarding SB 153) aids that effort by detailing state testing, enforcement, and other administrative provisions. Once submitted, the USDA will have 60 days to review and approve a state’s plan.

Some highlights of the interim rule are as follows:

• Hemp crops must be tested within 15 days prior to harvest by a Drug Enforcement Administration-registered laboratory.
• Hemp sampling and testing guidelines were drafted in separate documents attached to the interim rule, allowing the USDA to update the guidelines as new technologies emerge, rather than subjecting the guidelines to the constraints of formal rulemaking.
• Cultivators will not commit a negligent violation of the law if they produce crops exceeding THC limits if they can show they used reasonable efforts to keep THC amounts within federal law (0.3% THC) and the crops do not test above 0.5% (dry).
• Disposal of “hot crops” (those that exceed the 0.3% THC limit) must be collected and destroyed by an operation authorized to handle a controlled substance, such as a federal, state or local law enforcement officer or DEA-registered operation.
• There are no restrictions on the transport of hemp that complies with federal and state law (as stated above), confirming that hemp producers have access to national markets.

Hemp farmers in a state like California – which has been awaiting the issuance of the interim rule – are now anticipating the submission and approval of their state’s hemp plan, which will then unlock all of the benefits bestowed by the 2018 Farm Bill. Those benefits include the availability of crop insurance, access to commercial banking and federal intellectual property protection, and a shield against crop seizure by states or Native American Tribes that have not legalized hemp within their borders.

In short, the issuance of the interim rule is a game-changer for California and other states that have decided to develop a legalized commercial hemp market.

California hemp grow registrations have skyrocketed in 2019 due to Federal decriminalization and a nationwide demand for hemp-derived products.

Meanwhile, the state’s fledgling hemp industry closely monitored two 2019 bills that legislators introduced to take advantage of a vast new hemp business opportunity. One, Senate Bill 153, was intended to ensure that California’s regulations conform to new federal hemp laws. The other, Assembly Bill 228, was meant to bypass federal Food and Drug Administration prohibitions on hemp-based CBD in food, beverages and cosmetics.

As the 2018-2019 legislative session recently came to a close, the results were mixed. But the California hemp industry has continued to ascend.

Earlier this month, the State Legislature approved SB 153, which modifies California hemp regulations so that they line up with federal law and can be approved by the U.S. Department of Agriculture. SB 153’s approval is a key step to a wide open California commercial hemp market.  Governor Newsom is expected to approve SB 153 in the coming days.

In contrast, state lawmakers failed to decide on AB 228, which, in California, would have legalized the manufacture and sale of food, beverages  and cosmetics that include hemp-derived CBD. The bill died in the Senate Appropriations Committee without a vote and with little public explanation.

AB 228 contradicted the U.S. Food and Drug Administration (FDA), which deems products with CBD as “adulterated,” and prohibits them from being introduced into interstate commerce. The FDA position is based on its decision to approve CBD as an active ingredient in the pharmaceutical drug Epidiolex, which treats a rare form of epilepsy. In turn, the FDA deems CBD to be like all other active drug ingredients, which may not be added to food and dietary supplements.

The 2018 federal Farm Bill decriminalized hemp by removing it from the Controlled Substances Act. Meanwhile, the bill did not remove Marijuana. Marijuana is what the federal government has long called cannabis that includes more than trace amounts of THC. The State of California regulates a commercial cannabis industry separate from hemp.

The FDA prohibits CBD in food, beverages and cosmetics regardless of whether the CBD is derived from cannabis that includes THC, (the psychoactive constituent of cannabis) or from hemp. Hemp is defined as cannabis with extremely low concentrations of THC (not more than 0.3 percent on a dry weight basis). See our related blog here.

Thus far, the California Department of Public Health (CDPH) has followed the FDA’s restrictions on  CBD in food, beverages and cosmetics. Meanwhile hemp-derived CBD wellness products are filling the shelves of small businesses as well as large chains. This has created immense confusion among businesses and consumers.

The FDA and CDPH prohibition is seen by many as inconsistent with the 2018 Federal Farm Bill, which OK’d the production and sale of hemp, as well as the interstate commercial transfers of hemp and hemp products,  including hemp-derived CBD.

Following the lead of a handful of other states, including Colorado and Oregon, California Assemblymember Cecilia Aguiar-Curry (D-Winters), tried to address the federal CBD disconnect by way of AB 228. When the bill failed to get out of committee despite wide support, Aguiar-Curry vowed to bring it back in early 2020.

Legislative hiccups and regulatory confusion aside, the California hemp industry is gaining momentum. Q3 statistics from the California Department of Food and Agriculture show that the number of registered hemp growers in California increased from 74 in June 2019 to 292 as of August 26. In addition, there are now at least 629 registered help cultivation sites and 17,571 acres associated with growers and seed breeders. See a Q3 report compiled by CA-Hemp here.

Under the 2018 Farm Bill, hemp cultivation is fairly straightforward. Farmers must pay $900 and register with their County Agricultural Commissioner, who shares registrations with the state. During the past year, the state created a limited regulatory structure, knowing it would be amended. That structure will now be supplemented by SB 153.

Based on technical reading of the Farm Bill, counties may only allow cultivation pilot programs until the USDA confirms that their state’s hemp plan conforms with federal law. As a result, at least half of California countries have temporary bans or restrictions on hemp cultivation, but that is expected to change quickly.

California is said to be working on its hemp conformance plan and SB 153 aids that effort by adding testing, enforcement, and other administrative provisions. SB 153 also extends the state’s deadline for completing a hemp plan from Jan. 31 to May 1, 2020.

The California hemp industry is gearing up for a big 2020. Manufacturers are expected to continue using hemp-derived CBD despite the FDA and CDPH positions, and growers will be more than happy to supply them with product. But, the success of hemp is not entirely dependent on CBD. Instead, hemp is an extremely versatile and sustainable crop that can be refined for thousands of uses, including paper, textiles, clothing, biodegradable plastics, paint, insulation, biofuel, food, and animal feed. Some predict that hemp products will soon be everywhere.

Speaking at a major cannabis conference in Toronto last month gave me a window into the current Canada-California cannabis connection that will likely prove useful in representing clients from both locations in the months ahead. The bottom line is, at the moment, the Canada and California cannabis industries can help each other in more ways than one.

Most know that in 2018 Canada became just the second nation to legalize commercial cannabis (Uruguay was the first). And, much has been written about Canadian investment funds seeking cannabis opportunities around the world, and especially in California, which is expected to be North America’s largest cannabis market by far.

Given this context, my colleague Karen Balderama and I traveled to Toronto to speak at the O’Cannabiz conference specifically to explain the due diligence steps that Canadian investors should undertake before deciding to put their money into a California cannabis company. We have represented both Canadian and U.S. companies on both sides of financing and M&A transactions. As a result, we have a good sense of the upsides and pitfalls.

We know that California companies need capital and that Canadians have it and are looking for deals. What we didn’t fully appreciate was the great extent to which Canada can use help from California (and other states and countries) to make their industry flourish. That’s mostly because product supply and advertising is so extraordinarily limited in Canada.

The restrictions are central to the origins of Canadian legalization, which Prime Minister Justin Trudeau promoted as a way to keep marijuana away from underage users and curb cannabis-related crime. Those goals were key to getting both houses of Parliament to approve legalization and have directly informed the national approach.

In years to come, Canada may loosen its tight regulations and the U.S. likely will modify or end the federal cannabis prohibition. That might decrease the need for cross-border collaboration. But for now, the Canadian and California cannabis industries can help each other out in big ways.

In light of that background, here are our top three takeaways about the current Canada-California cannabis connection.

1)  Canadian cannabis operators (as opposed to investors) who want to expand need open markets like California because Canada’s industry is so constrained. An example from Toronto makes this point. At 2.9 million, Toronto’s population is the largest in Canada. So far, Toronto has allowed five cannabis dispensaries. Oakland, California’s population is 425,000. Oakland has eight operating dispensaries and nine that are conditionally approved, according to the City’s website. While visiting Toronto, I observed lines at cannabis dispensaries measuring full city blocks. Toronto is not unique. Cannabis retail is constrained nationwide.

2)  Canadians are scouring the world (not just California) for opportunities. One conference session I attended was entitled Cannabis Deploys Stage 3: Global strategy in an Accelerating Market. Speakers at the session emphasized that in the near future cannabis companies will emerge that have an international reach, including in Europe, Central America and Asia. The recent news about the Canada pot giant Canopy Growth agreeing to purchase U.S.-based Acreage Holdings, fed into this narrative. “All of the large Canadian companies will have a presence in the U.S.,” said Hamish Sutherland, the President of White Sheep Corp., which focuses on international cannabinoid production. “It’s not a matter of ‘if,’ it’s ‘when.’” Speakers agreed that global cannabis companies would have a significant presence in California.

3)   California provides an opportunity for Canadian operators to create brand identities not available at home. Canada’s restrictive marketing rules mean that their cannabis packaging looks like the U.S. generic food labels from the 1980s. The labels are mostly black or white, except for a red stop sign sticker that includes a marijuana leaf and the letters “THC” and a bright yellow label warning that cannabis can be addictive. The limited branding is a manifestation of the original mission of limiting underage use, but it makes it very hard for entrepreneurs to differentiate their products from others.

In other words, effective product branding is not currently possible in Canada. In contrast, California’s history of a longstanding semi-legal cannabis industry has built-in cultural cache that is perpetuated by innovators creating some of the most clever and creative cannabis marketing in the world, which is generally allowed under state regulations (other than obvious attempts to attract children).

[Thanks to Wendel Rosen environmental attorney Wendy Manley for this post.]

State Water Quality Permit

In 2017, the State Water Resources Control Board (State Board) issued a general permit for all cannabis cultivation to protect water quality (State Permit). Cannabis cultivation is broadly defined as “any activity involving or necessary for the planting, growing, pruning, harvesting, drying, curing, or trimming of cannabis,” including water diversions, preparing a cultivation site, or activities otherwise to support cannabis cultivation, and which discharge or could discharge waste to waters of the state. “Waste” includes any kind of pollutant that might reach surface waters or groundwater, such as nutrients in irrigation tail water and hydroponic wastewater. The State Permit is potentially far reaching, to include even indoor operations unless they meet certain conditions and file for a Waiver. See the State Permit here. 

Conditional Exemption

To be “Conditionally Exempt,” an indoor cannabis operation must occur in a structure with a permanent roof and a permanent, relatively impermeable floor (e.g., concrete or asphalt); discharge all wastewaters to the sanitary sewer in accordance with sanitary sewer system requirements; and implement “best practical treatment or control” measures or “BPTC,” which consist of numerous restrictions and express requirements for cultivation site development, fertilizer and pesticide use, activities in and around riparian areas and wetlands, water storage and conservation, among other things. Conditionally Exempt dischargers are also required to obtain the “Waiver.” In other words, “Conditionally Exempt” doesn’t mean you don’t have to do anything.

Outdoor cultivators who do not qualify for a Waiver as Conditionally Exempt are designated as either “Tier 1” (operations disturbing 2,000 square feet to one acre (43,560 square feet), or “Tier 2” (cultivating outdoors on more than one acre. In addition to BPTC, permittees must implement a monitoring and reporting program. 

Upcoming Workshops

Everyone in Cannabis cultivation, including indoor operators, should determine how the State Permit may affect their operations. Those planning to establish a new growing operation should examine the State Permit as early as possible, since site development and road building are subject to the State Permit, and there are numerous opportunities to organize the operation to minimize the costs and complications of implementing the BPTC measures. Those subject to the regional permits issued by the North Coast and Central Valley Regional Water Boards are expected to be transitioned to the State Permit this year.

Staff from the State Water Board will be available to describe the program and assist cultivators with permit applications and questions in two upcoming workshops co-hosted with other entities with oversight of the cannabis industry, including Cal Fish and Wildlife, Cal Department of Food and Agriculture CalCannabis, local planning departments, and CalFire. The workshops are in Laytonville March 26 (Mendocino County) and in Clearlake March 13 (Lake County). 

The State Permit is only one piece of the complex regulatory puzzle. For example, conditionally exempt cultivators may still need to apply for a water right to divert and use water.    

2018 was a big year for the commercial cannabis legalization and provided some clues for what’s to come. The year started with California’s recreational market kicking off just as now-former U.S. Attorney General Jeff Sessions rescinded the Cole Memo. By year’s end, the number of states allowing medical and recreational cannabis rose to forty-four and ten, respectively.

Some major milestones for 2018 included:

• The introduction of the STATES Act, which would give states the power to regulate commercial cannabis within their own borders.

• California’s first full year of legalization.

• Canada’s national legalization of commercial cannabis.

• High taxes on cannabis businesses and less than expected tax revenue for many states and localities.

These topics are discussed in greater detail in an article by Rob Selna and myself published in mg Magazine, which you can read here.

Court Ruling on 280E

Another major legal development came in late 2018: after a long battle, a US Tax Court ruled that the IRS can continue prohibiting cannabis companies from taking standard business deductions based on Internal Revenue Code Section 280E. 

As discussed in a previous post, Section 280E prevents any trade or business that consists of trafficking in controlled substances from taking deductions or credits for business expenses other than the cost of goods sold. 280E has been a thorn in the side of attorneys, CPAs, accountants and business owners working in the cannabis industry for as long as cannabis companies have been filing their taxes. It has greatly increased the cost of doing business and has prompted even small cannabis companies to adopt complex corporate structures, including management and holding companies. Another tact has been to undertake extremely careful, and sometimes creative, bookkeeping in order to minimize the overly heavy tax burden.

Fed up with what it perceived to be unfair treatment, Harborside Health Center, a major cannabis retailer headquartered in Oakland, decided to take a stand against Section 280E. Unfortunately, a Tax Court didn’t buy their argument. On December 20, 2018, the court ruled that Harborside would have to repay business deductions, estimated to be tens of millions of dollars, that it took on its taxes between 2007 and 2012.

Harborside argued that 280E did not apply to their dispensary earnings because about two percent of revenue came from the sale of non-cannabis related products like clothing and lighters. Harborside relied on the language in 280E, which states that its restrictions shall apply to any trade or business that “consists of trafficking in controlled substances” to mean consists “only of controlled substances.” The U.S. Tax Court disagreed with this interpretation and held that the sale of non-cannabis products was “neither economically separate nor substantially different” from Harborside’s primary business in selling cannabis products. Harborside has said it will appeal the ruling, but for now, 280E’s ban on standard business for cannabis operators stands.

On October 17, Canada became only the second country in the world, after Uruguay, to legalize cannabis for recreational use. Canada’s brand new recreational market allows consumers to purchase, possess and/or share up to thirty grams of cannabis and grow up to four plants. Notably, edibles can only be made at home, and other manufactured products, such as concentrates are prohibited. However, the Canadian government expects to make edibles, concentrates and other manufactured products available for legal sale by this time in 2019.

Since 2001, Canada had limited legal cannabis use to medical purposes only. The 330,000 Canadians estimated to use medical cannabis will still be able to access their medicine through the parallel medical cannabis market under the control of Health Canada, the Canadian governmental department responsible for national public health.

Individual provinces and territories will have regulatory control over enforcement including minimum age requirements, personal possession limits, additional restrictions related to residential growing, where and how to purchase cannabis products and legal consumption locations. Currently, Ontario and Nunavut provinces are only permitting online sales via their government-operated online stores, while other provinces allow for private licensed stores, government operated stores, or both. Quebec and Alberta have opted to make the legal age of consumption eighteen to be in-line with their alcohol rules, while nineteen is the prevailing legal age in the rest of the country.

A big question Californians are asking is how will Canada’s legalized recreational cannabis industry impact the U.S. cannabis market? Most would agree that Canada’s nationwide legalization is a huge step forward for global acceptance of cannabis and will hopefully provide a workable model for legalization in more countries. But the competition it may represent is discouraging to some U.S. operators continuing to struggle with inconsistent federal policies, including banking limitations on the one hand, and large tax burdens on the other.

Many California cannabis companies, grappling with the high additional cost of state and local compliance are feeling vulnerable to competition and buyouts by well-capitalized Canadian enterprises. These fears are not entirely unfounded. The twelve largest Canadian cannabis companies, which are collectively valued at about $42 billion, are able to take on more traditional investors. An example is Constellation Brands’ massive investment in Canopy earlier in 2018. In contrast, many investors are still wary of pumping money into California companies facing the federal ban, high taxes and a slow, convoluted path to state and local licensing.

Canada, like California, foresees an on-going battle with a powerful and entrenched black market. Despite that, Canada is shaping up to be the global leader in cannabis capital and investments with an estimated 4.9 million Canadian cannabis users and a market expected to be about $5.6 billion.