How To Sign Illinois Banking Agreement

How to industry sign banking illinois agreement

[Music] we're going to talk about why agreements and contracts are so important and how they set you up for success for the long-term of your business collectively on the panel today you've got probably two to three decades worth of legal experience which is a really invaluable lesson as we charter these waters that are consistently evolving and turbulent during the emergence of cannabis regulation here in California and across the country if not the globe so first I'd like to outline what we're gonna talk about this evening we're gonna go through investment agreements and then agreements throughout the cannabis supply chain focusing on what that supply chain looks like here in California first and foremost I don't know all of you but I say this consistently as we talk about investment agreements moving into 2019 the way that I look at it for my clients is that you've got three options as you move throughout this process you're going to be an acquisition target and whether or not you are the crown jewel and somebody's Canadian IPO which is the topic to shore at the moment is going to be how well you are set up with your contracts and your internal structure or you're going to be able to survive an acquisition event otherwise you will be extinct if there is no secret option number four and in order for you to survive in one of the first two buckets and be a desirable acquisition target you need to have good investment agreements so with that I'd like to open it up to our panel to advise or give an overview of what are some of the fundamentals for in good investment agreements startups and what you look for on the back end during a due diligence check as an acquisition target you can start with Michelle if you've been in the industry longer than the last two years then you know that back in the day pre legalization papering up or making contracts between businesses and other businesses or their investors was never really something people did the whole point was to not leave a paper trail to avoid getting arrested by the cops etc so now that we're moving into legalization you know now it's getting better getting people to learn how to be comfortable with us papering up everything so back five years ago it would be a very typical deal where someone's cousins friends lawyer brother or something gives a 100 grand cash to a dispensary and then I promise I'll give you 10% of my proceeds that's not gonna fly anymore you know now we have to pay for up all those investor agreements these private offerings and it's a lot of paper and there's a lot of due diligence involved and again back to the same problem of not keeping a paper trail due diligence is a challenge in a company that isn't accustomed to keeping accurate books lots of these companies books are cooked they handwritten receipts it's very hard to get a true accurate feel of what a company's financials are are so investors have a unique challenge in this and industry than they do in any others and it's very hard to value a company for those reasons there's a lot of obviously cannabis related disclosures that you have to put in your investor Docs things like you know telling potential investors that cannabis businesses are subject to AEE and don't have access to banking so you can't really properly track your investment where all your funds are going mix it's not really for the faint-hearted investor but you know these are all kind of things depending on the nature of the transaction how much money is involved a accredited investor or not accredited investor there's a lot of different things that go into it and it's kind of really specific to each situation but the over arching the premise is that you need to have you need to be properly papered up for two primary reasons one you face extinction after being acquired you face crazy securities fraud related accusations charges fines whatsoever you know what have you and then you also if you're gonna try to impress a legit investor and they see that you don't have things buttoned up on paper they're really gonna think less of your company and whether or not you're a viable investment so all around it's a it's a challenging transition but and it's not a easy one to go through but there are a lot of different things to go through that are very specific to cannabis so I'm Michael Chernus I've been an attorney for more than I care more years than I care to tell you and been practicing in the cannabis space for ten years and the ten years has seen a lot of changes in terms of what all work is because it used to be keeping you out of jail and trying to keep you out of trouble and now it's really about protecting you as Michele said through papering transactions and and in that way it's not unlike any other industry there are nuances having to do with federal issues and there's uniqueness about the regulations that that you have to deal with in the cannabis space but with respect to investing in startups what what I've seen when I've been brought in to like private equity transactions recently is there are challenges that are unique to cannabis and I think one of the challenges is this is a brand new industry we're in day one how do you evaluate a company's financials when there's no history to base it on how do you evaluate their for any of this stuff in other industries when you're making an investment you have some track record maybe to look at or at least you have a track record of an industry that's or another comp in the industry here you don't have that at all so I can't tell you how many times I mean it happens today a client who want to invest six million dollars to buy a piece of property and these licenses and the financials project blah blah I'm like I don't even listen after that the financials are just there made up because there's no history it's not to say that financials have no basis in reality but you really need to dig in and try to get underneath these financials there's different ways of valuing companies there's different ways of doing financial projections and you it's really incumbent upon you to look beneath the paper and try to get some understanding of where the numbers came from so that's one huge issue another huge issue that we keep coming across especially if you're gonna be on the debt side and you're gonna do a debt transaction that maybe involves a convertible note where if the borrower doesn't meet its obligations your debt turns to equity the question is so now I'm an equity holder in a licensed business how am I gonna actually effectuate that ownership because every city has limitations on how licenses can be transferred so you may now be the owner the equity holder in a licensed entity in LA or some other city but is LA gonna honor your rights as an equity holder are you gonna be able to execute upon that interest those are huge questions that know that anyone really has a good answer to and then there's there's other nuances that keep popping up like we're investing in a company that is a non profit mutual benefit corporation it's supposed to convert to a for-profit entity it hasn't happened yet are there going to be problems with that so those are some sort of unique things that we keep coming across as well as you know potential liabilities that we maybe if you're an investor potential liabilities that may pre-exists your investment a lot of which are hard to calculate because not all these businesses have great track records and just to give you an example you may be investing in or acquiring an entity that's been operating under the collective model for five or ten years but maybe they didn't pay any sales tax what is your responsibility for that who's gonna carry that liability so from my perspective as somebody who's to do a lot of litigation but the due diligence focuses on those kinds of issues liabilities what's gonna happen if things go sideways will I be able to execute on my interest okay I'd like to know from you since you're representing growth companies from idea to exit which I like as we see the great constriction or consolidation of the market with M&A because some operators maybe got a license but didn't have enough money to effectuate that license to get it through Landry's entitlement to operation how are you advising clients and what would you suggest for maneuvering through that M&A process I'm Jay I work at Clark Newburgh were women-owned law firm in San Francisco Sacramento Santa Barbara in Los Angeles I grew up to be a corporate lawyer which everybody dreams about becoming when they're little and the neat thing that we get to do is help little companies try and become bigger companies right being an entrepreneur is super difficult in any industry cannabis that much harder a couple thoughts one of them is no one ever regretted spending too much time with their attorney right people regret like not having flood insurance people regret not spending enough time with their attorney find an attorney you like and you're willing to say I screwed or even a curse word find an attorney you're really willing to share what's going wrong you'll never regret it corporate law is moving really quickly especially around cannabis lots of companies have been operating with non profit mutual benefit corporations with LLC's with corporations spreading their operations between different companies for years filing inconsistent tax things all of this can be fixed but the sooner you start the better which I've heard the other panelists talk about there's a planning process that you can really go through to clean some of these things up before you become in this M&A process the biggest challenges we see are companies who don't realize until it's too late we have companies come to us and somebody wants to buy them for millions of dollars and they're so excited and it turns out they never actually purchase stock in their own company this isn't rare because they thought they had done it because maybe a couple years ago they're cousins friends husbands neighbors nephew got them set up with a non profit mutual benefit and they started operating but they never actually purchased any equity in a company the crystal equity where they never issued themselves membership interest in their nonprofit and we say there's this universe of acronyms that you've got to get a hold of and you can get a hold of there's also I'm trying to find a nice way to say this but there's not always awesome advice but there's a lot of people giving it accredited investors hasn't been requirement in since November of 2016 right some of your investors will be concerned about this but many of your investors shouldn't be concerned about this at all all of your companies can raise up to five million dollars with zero accredited investors you don't have to disclose anything to them this has been an SEC rule since November of 2016 and I'm not saying you should do that but it's an option that's available to everybody the most important thing that I think cannabis companies need to know is this corporate law stuff can destroy you but it can also empower you if you set this up right you'll get great tax rates if you set this up right you'll have clear ownership you'll feel empowered to raise money through convertible notes to find a great M&A exit but this is really one of those like you have to get your vaccines you have to spend more time and money on this then you want to early because if you don't you get that horrible news that somebody wants to buy you for ten million dollars but you don't own any stock in your own company like that happens because people are confused about what they actually purchased a couple years ago if you find out too late you don't own stock you think okay I'll just buy it but if you buy it today and sell it tomorrow you get nailed on taxes you could lose like a third of the ten million dollars that you're hoping to get I know much more about investment stuff then I will about the supply chain stuff so so I'm gonna okay I'll finish up but on the deal with corporate law is it's scary at first and then it's really empowering right it can like really the purpose of the Corporations code is to let you start companies that grow and expand and become more valuable and they can do that cannabis companies like any other companies should use the Corporations code to build and they can do that and you can do that with a lawyer you love with a lawyer you love happily every day Lord Allah love your lawyer love you a lawyer Albatros that takes you down if you don't invest in it it's very difficult and it hurts right it hurts to have to spend that money it hurts more later when either you can't take ten million dollars or your evaluation should be a tax and all the sudden you're getting pennies on the dollar because when somebody does your due diligence when they look up your proverbial skirt as a business and they see you haven't kept minutes ever right they asked for a corporate book which is very simple and when you're doing a due diligence and you don't have one you can't show the train of events and transactions that you've had then all the sudden this valuation you have this great business that you put your time energy sweat tears into all the sudden becomes greatly diminished and somebody can say that to you simply by not having records and not loving your lawyer so with that building blocks or with that framework in mind really we want to turn to the devil in the details and that comes with how are you going to run your business prior to finding that exit strategy and that's where we want to look at how the supply chain acts and how agreements with between supply chain actors occur I think we can start at the natural place which is cultivation right we have no industry if we have no cultivated flour to then turn into other manufactured products or sell at the dispensaries and so with that comes sourcing agreement and how if you're a manufacturer do you go about sourcing your products and what does that mean how do you interface between a cultivator and either a distributor or cultivator and a manufacturer and what has our panelists been exposed to and how do they advise operators to maneuver if somebody comes to them and says I want to purchase from you X number of pounds a month or a supply any time you're dealing with a cultivator you're gonna have to deal I guess any operator between any awkward you're gonna have to deal with your distributor so the distributor contracts and the connection between the cultivator and the manufacturer or the cultivator and the retailer you're all going through the distributor so that are kind of that the mandatory middleman and that's where all the details get a little confusing the we've been seeing a lot of a lot of our at least my work load lately has been dealing with these distribution contracts in light of the new regulations which as we all know keep changing which we probably won't expect a final version that's adopted until wet like early 2019 something like that so these distribution contracts and at least I've been seeing they they change they look completely different when they were first started up last November and they're evolving as the regs are evolving and now it's a completely new template or new beast and every single time we have to take a look at it but things like from the cultivator to the manufacturer I guess I'll just use like a case study let's say we have a grower in Salinas County a green house who wants and we got an L a manufacturer who wants to source the the the Sun grown from up there does how do we get it down there does the cultivator have a distribution license can the cultivator who has the distribution license transport that down to LA or does the manufacturer in LA have a distribution license can the manufacturer use its distribution license to go up north and go get the flower itself or do we just use a third-party distributor who has a transport only license to just take it from A to B so you there's a million ways to skin a cat each business has its own licenses as its own internal strategies what have you but but depending on who's gonna do that part that just the transportation the testing of you know collection of the excise taxes that's all distributor so you got o really make sure whatever distributor you use whether your self distributing or using another party you got to make sure you trust that distributor that distributor is buttoned up is a good operator knows what it's doing and in those contracts there's a lot of and then there's other things to think about is that distributor not only transporting and testing but are they gonna be packaging for you you're doing all the you know the packaging and labeling compliance so someone else could even do that part for you you can add another party just a straight packaging company and so you got to figure out where all these players who are gonna fit all these pieces whether that's you by yourself or up to four different companies who knows and depending on how that business structure is modeled then you can kind of get into what this contract is gonna say and what that contract is gonna say it's gonna give delineate everyone's roles and responsibilities and obligations clearly it's gonna determine things like if the packaging ends up being non-compliant or if the product gets recalled due to contamination who's footing the bill for that who's responsibility is it are you splitting the baby how are you gonna figure that out and we got a lot of I got a lot of people asking me well what's the standard what's the standard rate for distribution fees there's no such thing as a standard rate in cannabis there's no such thing as standard anything in cannabis so those are all business questions how you get up those numbers how many different operators you're involving in this supply chain really will impact how you structure your contract but at the end of the day the most important thing a lot of people just go into the contract hoping look they're gonna make my product for me I'm a brand they're just gonna make it for me and they're gonna sell it out and they're gonna give me royalty fees for it's not that simple you guys got to throw in all this other stuff about what happens in the worst case scenarios we're gonna be the debbie downer attorneys who tell you about how easy it is to get married but how difficult it is to get divorced but it's very true so you got to contemplate all these worst-case scenarios and figure out beforehand and agree beforehand what's gonna happen like I was tiling Pam earlier we've got I've encountered a brand who is a brand that was co-packing with another manufacturer that manufacturer use a distributor licensee transport only to you know transport product from A to B to the retailer that distributor has all the cash taking it back to the manufacturer and gets pulled over by ATF one hundred and eighty thousand dollars in cash seized federal forfeiture and now the parties are fighting about you file the forfeiture action a you file the forfeiture action we got the licensee who doesn't want to raise any red flags you obviously got the brand who wants their money but you know now you got this an uncomfortable situation where there's a lot of money that you need to get back but no one can agree on how to do so so think about horror stories like that prepare in advance I know it's no fun but it you'll you'll thank yourself for it later we've seen a lot of brands that were very profitable and knowledgeable prior to regulation where you had to go and source a license they have a brand so they have something that they can license in the market where somebody else was able to capitalize on securing a property and getting through licensure how do you go about doing these licensing agreements so that your brand can survive through another licensee they think that is something that is of interest and is a very vexing complicated area of putting those contracts together I actually know the answer to that question but before I before I get into that I just want to touch on the cultivation issue what makes the cultivation and the manufacturing a little bit different as far as I'm concerned is cultivation your product can go down two paths it can go to the distributor retailer path which makes it similar to manufacturing and then as Michelle was alluding to you're dealing with issues of who's gonna package it you're gonna package it yourself you can have the distributor do it the testing all that risk of loss stuff which is a big issue risk of loss or you can agree that some or all of your product is going to go to a manufacturer to be turned into brownies and oil and concentrates and if you go down that path in some ways I think your life is a little simpler because you don't have to deal with a distributor for that piece of it you can just have somebody transport it there's no testing that's required by state law before it goes to the manufacturer you should certainly test it on your own but these are two very different paths I mean I have some clients that are doing rows where all product just gets freeze I think it's called free shipped directly to a manufacturer to turn into oil and then other people obviously they want to get their product out there is flour and as a brand so those are very different paths and they involve different different contracts and considerations and then you know there are these concepts and maybe Jay could talk more about it but you can enter into a requirements contract if you're a distributor or a retailer where a cultivator has to meet all of your requirements and give you as much flour as they as they can produce and if you're on the other side of you're a cultivator there are contracts where basically you may be obligated to give all of your flower to a particular distributor or retailer as much as they want so there are different ways of like engineering those kinds of contracts but the question that Pam asked me which is really I think a an interesting question is we're a brand we have some traction out there but we don't have the means to get a license we don't want to get a license we don't want to spend all that money on real estate how do we stay out there and actually I think what at least when I'm seeing is there's a lot of brands out there that have just opted like it makes more sense to not have to go through the hassle of hiring someone like me or Pam to get a license and instead we can just hire someone like Michelle to negotiate a contract between the brand and the and the manufacturer so white labeling is huge I have a client and Michelle and I have been actually on opposite sides of a transaction where she represents a brand my client makes the stuff my client packages it my client distributes it her client designs it so and that model that white label model and for those of you that don't know the terminology essentially there's a manufacturer out there that's got a license to manufacture they have the machines they make the oil and they can put her clients label on it or J's clients label on it or my clients label on it and maybe there's some there's gonna be nuances and differences in terms of the mixtures and the terpenes and the blends and all that but that is a different and in some ways much more affordable model for a brand to survive what makes it challenge social media I mean I have clients that have brands and you would think by their social media like their Apple but really they're very small but the social media and the PR makes them seem much bigger than they really are but in those contracts there are so many complexities because you have the brand on one side which hopefully owns intellectual property which is like a whole separate conversation how to acquire it what it is and then you license the intellectual property to the manufacturer so the manufacturer can put it together and sell it and then the manufacturer will either turn it over to a distributor or there'll be the distributor and so all those different pieces have to be worked out it's not super complicated but there are some details again dealing with who's gonna have insurance what happens if a product is contaminated whose responsibility is that well you design the cartridges the cartridges are defective well you put the cartridges together with the packaging it's your fault so those kinds of issues have to be worked out and honestly I don't think they're unique to cannabis they're just unique for everyone in this room because it used to be that you just grew it put it in a bag brought it to the dispensary and you just waited for your money but now it's a little bit more complicated and it's a little bit more mainstream I think it's helpful sometimes imagine um somebody's like behind a soundboard with like 16 different like levers to twist right that's a commercial contract one of the levers is who's responsible which percent you or me it's responsible if it gets seized in process right between the two places are you 100% or my a hundred percent like there's a knob how many days late is the product before there's a penalty that's another knob so each one of you probably has one or two transactions you're constantly doing if you're a cultivator you're constantly selling to dispensaries or to distributors or to manufacturers if you're a manufacturer you're constantly buying from cultivators and maybe you're sending it out to distributors there's one or two deals you're constantly doing spend a couple hours with one of these people and figure out what are like the ten things you're always negotiating in those two transactions what are the 10 things you always have to deal with and then they'll tell you the six ones you're not thinking of spend the time get to good form agreements for the two deals you do every day right and then get a little familiar with the ten different knobs because wool writer and Greek but you guys can negotiate with your counterparties you know what 15 days is too many okay so this parts gonna be 15 days who should bear the risk if it gets seized in the road who should bear the risk if it gets moldy like these 16 different knobs you know when Google sells something it doesn't do a new contract each time it takes the form of selling stuff and then goes and it sales people fill in the blanks it's more complicated than that but you want to have a couple forms that you use all the time so that you're not reinventing the wheel right so think hard about what are the two or three things you're doing several times a week or that constitute like the bulk of your sales and your purchases and then invest like make this tool make this template the goal for us is you get this really polished like mercedes-benz that you can drive because you know how to use the so we got like a soundboard we got a car we got all kinds of things but the goal is for you to get this tool that you can use all the time there are a lot of knobs it does get really intricate but you probably do one or two transactions several times a week right like this will get commodified and the sooner you can have some like confidence in what you're doing I think the sooner this will get demystified right because we're buying and selling agricultural products that become finished products you can you guys know how to do the business side of it we can show you how to do the legal side of it and then it's perfect I mean what Jay said was really empowering to you to be able to ask those questions and the only way that it will become normalized that agreements are the mainstay of this industry is by you as operators requesting them of each other because I think it's important to note that we can sit up here tell you how important agreements are but unless you were willing to invest in them invest in yourselves and ask that of each other as operators that's the only way we're gonna see this normalization now we've also talked about regulatory changes we're seeing those potentially coming by the end of the week we've also seen some interesting legislation which as we've talked about distribution agreements I it's interesting some of you in the room may be distributors what does SB 311 have come into play it was an urgency bill it came into effect right away as soon as it was signed and it allows for distribution to distribution transfers right distribution agreements down the line the storage only part of what distribution movement throughout the state means a few of our products coming from up and humbled and it needs to get down into LA and we're also under this California driving restrictions you can only have a driver in the car eight hours you can only stop in a secured area when your store product and these COAS are moving along the supply chain how has that affected distribution agreements and how you're advising clients JC your heads shaking vigorously so you have some common I just moved here from Oakland so a lot of my clients are still in North Bay and they spent a lot of time like looking at naps to figure out how long does it take to drive from Mendocino like how far could they get before the driver needed to like stop and where could they get licenses and I think at this point they have a license in Culver City they have a license in Mendo and that's kind of as far as they can go I unfortunately don't know about this new legislation that it sounds like will change their business plan so you should talk to my clients I feel like I should be the moderator and you should be on the panel but she knows that she knows a lot so so SB 311 has to do with sort of plugging a gap that was or a disconnect between mikasa and the regulations mikasa had contemplated that the product would go from manufacturer to distributor from distributor to retailer or from cultivator to distributor distributor to retailer but you have these distributors that are up here and you have retailers down here and the logistics of it made it really challenging so the regulations contemplated that you could have a storage only or transport only distributor where there could basically be a handoff from the primary distributor if they will if you will to somebody else that would then take the product the rest of the way or store it so that it could then go from your spot to the retailer because so the way they divide up the responsibility is that the product can't leave the cultivator if it's finished product it can't leave the cultivator and if it's finished product it can't leave the manufacturer until it's batch tested and it goes to a quality control check so the distributor is in charge of that the distributor can then take it from their facility to the retailer or the facility or the distributor can take it to another distributor who would then store it and then transport it to the retailer without that second distributor having to go through the same batch testing and quality control process so what SB 311 did again is it reconciled mikasa with a change in the regular nations that had authorized that sort of secondary use of a distributor so if you're a distributor what SB 311 now allows you to do is essentially piggyback on another distributor that might be located a little closer to the ultimate destination the products are going to but here's the wrinkle the money so the distributors are performing generally like five different functions they perform a quality control function to make sure the product is labeled correctly they promote they perform the batch testing process to make sure it gets batch tested before it gets released they have to collect cultivation taxes they have to collect excise taxes they have to then remit those taxes to the California ftda or whatever it's now called and then they have to transport it but if you're now using that transport only person to do part of the transport how do you divvy up the dough how does who gets what like that's a nuance that again like there's no right answer for that there are sort of some standard rates that are out there but it's just another thing to think about if you're if you're a product manufacturer or if you're a brand I am in LA but I want my stuff to be in the Bay Area how am I gonna get it there who's gonna be in charge of that is it me is it my distributor is it my manufacturer these are all things to kind of be worked out there are nuances to nuances exceptions to exemptions this is how contracting works and talking about distribution one of my favorite agreements that comes off of a distribution agreement s testing lab agreements and it's ones that I don't see done often enough especially with distributors - testing labs and riffing off of that is recall procedures every distributor should have recall procedures if and when there is an issue with a testing lab I know we're gonna hear from operators later but one of the critical components of why testing lab recruitments are important is we testing lab equipment is very sensitive and it is very expensive and anytime you have sensitive and expensive equipment the subsidiary to that is that it will at some times fail or need to be recalibrated and what happens from the bcc's point of view is that anytime the bcc sees discrepancies that are too wide and you as a testing lab can no longer issue a coa or certificate of analysis what happens in the following situation that i will present to our panelists it's called a legal workshop in this situation where you would have a testing lab who was taking in product there discrepancies were being called into question by the bcc and in in this entry room where they're trying to work with the bcc they continue to take in batch samples from a distributor that distributors product is then in cue from the current regulations pursuant to the readapted regulations that we're working under it says that if the bcc were to pull that testing labs ability to issue a cui then all of the products is stopped in the pipeline because it cannot go to another testing lab either a testing lab that is owned by that testing lab licensee if it has multiple labs it can't move it and it can't contract with another licensed testing lab to test that product so that product is sitting either the batch samples are sitting at the testing lab and have you made an arrangement between the testing lab and the distributor if you have to take a secondary set of batch sample testing or if it's sitting not at your distributors warehouse it's sitting in a transport only storage storage distributor it's taking up space there and how long can it take up space so what is a distributor and then therefore a manufacturer or cultivator who's waiting for this product to be released do in that situation and it's interesting to note these are white testing lab agreements are important the only licensed type in the entire supply chain that the BCC and their infinite wisdom has said does not need to carry insurance is a testing lab so what is it that you would advise your client to do and I'm gonna section you all if you were the testing if you were representing the testing licensee if you were representing the distributor or if you were representing a manufacturer or cultivator who had given their product to a distributor so if anybody wants to jump out first and say who they yes we're gonna roleplay this who is who if you want to represent one of these clients raise your hand or I will assign them I do it at random okay Michelle you are going to represent the cultivator or the manufacturer Michael you're going to represent the testing lab and J you're going to represent the distributor what do you advise your client once the bcc has pulled your the testing labs ability to issue any more cos and the product has already been taken in do you if you guys agree to switch roles you can Michael who said I could issue it it's already been done and we're gonna highlight why you need to have a good contract so what would you advise them if in the situation that we have now where they have not contracted and what would you have advised them originally so we can see what this agree why agreements are so important even though as a testing lab maybe you're not obligated to carry insurance you're I mean it would be it would be unimaginable not to happen they would I can't imagine that they wouldn't have insurance and and honestly like I think the magic that would happen here is in having an insurance policy that contemplates this kind of scenario like I give you I gave you I give you amazing credit for having thought this up because I don't think a lot of people are at this level where they're thinking of this issue what happens when you're the manufacturer and you've entrusted your product to my client and my clot it my client basically has a freeze order my client is unable to continue doing operations hopefully my client has insurance but really our hands are tied and the issue I think has to do with hopefully contemplating in advance what that this scenario and apportioning the risk of loss but I would imagine frankly that everybody has insurance that would address what is amounts to a business interruption situation that's my two cents not that I wouldn't love to take credit for fully coming up with this hypothetical but it is in part based in an actual client issue or issues that are occurring I would say and it is interesting to note that sometimes testing labs can actually be the most difficult to insure I'm sure that we will hear about that in our next panel where the operators are discussing it but they are not always able to provide the level of insurance of these types of situations and business interruptions because this is what you're contracted to do so if your shut down by the BCC and you've been potentially issued a prior warning about the situation and you're still in taking products how does that affect your contract negotiations right because the BCC by the time they're pulling your ability to issue a test there have been multiple steps where they've intervened because they've seen an issue usually you're not having such a jarring circumstance where the BCC is coming in unannounced so at what point and have you previously contracted for it if you are the distributor or the manufacturer cultivator to say you shouldn't be taking in any additional tests with this oversight that you are not allowed to cure the issue on the back end once you take it in-house so I don't know if we want to look at it from a distributors point of view I don't know the answer to this question it's a strong question I what occurred to me was to say to some of my clients this is a good exercise for everyone ask your Lord here are the three things most likely to go wrong here are the three things we know are going to go wrong in the next two years do our form agreements provide for what to do in that scenario you talked about risk factors a couple minutes ago the way companies often come up with risk factors is they sit in a room and say if we miss next quarter what will have happened to cause that like what are our likely failure patterns basically I didn't think of this failure pattern for testing companies it seems like we should think about it but if you ever do sit in a room with your lawyers for three hours and say we want to come up with a really good form say to them at some point here are the three things that are going to go wrong in the next four years they're going to happen at some point we want our agreements to provide for some path out of that everything is a defect everything has some failure rate and that's fine your agreements can provide for like a detour for you know what's the I don't want to see self-destruct button but alike happy route out of a jam a parachute that's great that's great that's great yep well usually cultivators and manufacturers even now nowadays they very rarely are not gonna have a contract already in place so first things first let's take a look at the contract that's in place which hopefully is a good one hopefully it it it passed the buck off to the distributor it's the distributor's problem hopefully there's indemnification clauses in there protecting the cultivator and if it's a really really bad contract and it doesn't give you all those safety nets then we're still gonna analyze the contract which hopefully exists for for at least breach breach causes of action and it's you know it also kind of depends whether or not there was a contract between just the cultivator and the distributor or also was the cultivator having a had a contract relationship with the testing laboratory then that's called privity by the way well do the contract who did the cultivator had privity with the distributor the lab everyone up the chain so you kind of need to assess who's liable to who who has a duty to whom in this in this supply chain situation once you analyze the contract and it kind of smells like good old-fashioned litigation with the testing lab that's how you're probably gonna end up getting your money yeah so we'll do though we'll do that we'll do it that way I'm suing your lab my right and whether you're doing it in concert with the distributor or not or whether you're suing your distributor because remember when do you pay the money when have you contracted for that release of the money for the products because J and I'm sure you're sitting in this situation is the distributor I don't want to pay the cultivator or the manufacturer until I get a clean CoA right because I can't resell it so if you're taking it in at what point to your point about the knobs and the levers when is payment being released and so there's a lot of different nuances in this one fact pattern we started in one place and we're talking about 17 other different issues that take you down a different path I think what you've heard and what you've experienced with this exercise is that there is no one right way to do a contract and there are multiple different parties that are gonna experience different levels of discomfort when things go wrong and they do so to riff off of this example which I also think is important is talking about both recalls and defects because this is something that I'm sure if you all of your operating is a big question I've been this question by some of my operators well if I don't like a product and I take it in can I destroy it as defective it's not selling no you cannot defective has a very specific reason it is already a term of art in what is it California Code of regulations what is a product defect it literally has to be defective that does not mean it doesn't move off your shelves that does not mean that people don't like it but what happens when there's truly a recall what happens in an instance again with a testing lab a CoA comes back and then all of a sudden there's a discrepancy and after 24 hours or 48 hours and let me tell you once a CoA comes in product is moving right it's going from the distributor to a retailer so within 48 hours even 24 hours sometimes product is on a shelf and so what happens and in how far can a testing lab if they have to start issuing a recall because there was an actual discrepancy in the CoA that was reported how is that manifesting itself and there are you know there are only specific required recall procedures for the Department of Public Health right although even though it doesn't say it for the BCC or for DFA they don't have specific outline recall procedures if you're a distributor your requirement for the BCC is to provide inventory control and recall procedures so it doesn't necessarily matter where they are housed between the three agencies at the end of the day this is the distributor has to have this in their inventory control plan as does a retailer how do you go about doing that and whose responsibility is that and where is it in your plan bringing it all the way back to what Michael originally said about either applications or licensing your product if you're you know advise clients as they move forward with this and you're doing a licensing agreement and your licensing agreement with your brand also has to contemplate brand reputation what do you do in a recall procedure there is that something that you would negotiate between the in a white labeling agreement if you have to do that to protect that brand integrity where does that happen does it happen with the distributor is that part of a distributor or conversation with the testing lab or a distributor with manufacturer cultivator I'll let you guys opine on that well in the case Michael and I have our my client the brand is responsible for designing the product designing the packaging making it nice and pretty Michael's distributor / manufacturer client is responsible for assembling at all making sure what my client prepared is compliant with packaging and labeling etc making sure the product the actual extraction actual assembly is conducted by Michaels client so there's obviously two very distinct roles here kind of some overlapping I guess in the packaging and labeling compliance area but in our situation you know we put recalls you know who's responsible for recalls is depending on what the recall was for if it was packaging and compliance I am packaging and labeling I think we slipped a baby on that because of our our shared rules in it if it was due completely to product contamination or something that Michaels client did he was responsible for that so that's kind of the the fair approach that we took with that at least does anyone still want to be in this business like so so so you know he listening to us talk Ike and imagining myself over there I would imagine that this is distressing but there the reality is the good news is that there are lawyers out there that and they don't even have to necessarily be cannabis lawyers but it's probably better that they are but there are lawyers out there that can help you with these problems like you make the stuff we hell it's it's like what Jay said we we we collaborate with one another so we get paid and we stay up late at night to think about these issues so that you don't have to think about them the reality is that that you could you'll never anticipate in a contract all of the things that can go sideways because if you did then there wouldn't be a need for litigators because what litigators do is they litigate the gray areas and while as a former litigator it's you can reverse engineer where disputes have happened in the past and try to keep them from happening in the future by addressing them in better prepared contracts you could have a contract that's 100 pages long and you'll never anticipate things that you haven't anticipated there you just can't so you can include in a contract hopefully you'll address like as Jay said you'll identify the ten things that really matter and you'll scope it out what happens if somebody steals something what happens if it fails a test what happens if the product doesn't taste the way it's supposed to taste who's responsible for that and then there's like a bunch of stuff that no one's thought of you can cut put in a contract some catch-all provisions that protect you and I think actually Michelle in the contract that we did added some language that I thought was really great for her client and didn't really rub me the wrong way and it it was broad enough to kind of protect against an unanticipated situation it was something like hey listen you're making my company's product you know our reputation our goodwill is on the line like carry yourself accordingly to protect us so it's sort of like a provision that maybe if there's no other provision in a contract that specifically addresses a situation creates a duty on my client's part and that if I fail to do something that's maybe not specifically or expressly addressed her client can rely on it to say hey dude look you really knew better and you should have done that better so I guess what I'm saying is don't don't be distressed and try to trust us to help you as far as the specific question that you were asking I honestly filibustered and I don't remember what it was but I know I had a really good answer for it that's save for later so that everybody stays he'll figure it out and come back at the end I'd open it up to everybody else's questions cuz you've listened you I'm sure all understand that the devil is in the details and you should what love your lawyer it's like my new favorite saying but does anybody have any questions as we wrap up one into the question was we've been focused on see corpse but what is the benefit or why how would you advise between a c-corp and LLC incorporation so at the point where you're selling your company you're probably either one or the other so you wouldn't have the ability to change if you go from a corporation to an LLC y u'll get a big tax basically when you're selling your company you want to get long-term capital gains you could get that either as an LLC or as a corporation so from the sellers perspective it doesn't really matter because you want the same tax treatment either way from the buyer's perspective there's a whole bunch of other factors that go into it you can convert from an LLC to a Corp or former Corp to an LLC one of those paths is expensive one of them is not but you wouldn't do that right before the acquisition because you would kind of eliminate the goal long story short it doesn't really matter if you're an al Asiri corporation when you get sold for your personal tax consequence don't worry about that the only thing I would add is that that that whole issue of what do we want to be and when it comes up at the startup phase it's not one size it's all I mean personally I prefer using LLC's because I find them easier to work with in corporations but they have different tax consequences there are different there are ways of turning LLC tax consequences into the same as corporate tax consequences in terms of like using an S Corp or just having an LLC that's taxed like a corporation but corporations and LLC's have are taxed very differently there are different 280e consequences especially from the purview of state law which is a complicated issue I'm sorry I brought up but I can talk to you about it afterwards but it's definitely not one-size-fits-all and I don't mean J would know better than I but I don't think I don't think there's a straight answer for that it really depends on your own circumstances depends if you're in retail are you on the production side what are your 280e consequences what's your exposure to risk the question is we're dealing with an industry that's legal under state law that's illegal under federal law and what's is there an issue for enforceability of contracts is that more or less it so I think historically there was a larger concern with contracts being invalidated both under state law or in state courts and in federal courts I'm not aware of since the legalization effort I'm not aware of any courts in California California courts state courts refusing to enforce a contract that selected California courts as the forum I think a lot of people are fearful that federal courts will not enforce contracts and so they will put in a contract a forum selection clause that requires you to litigate in federal court the thing I don't know is I don't know if you ended up in federal court if a federal court sitting in California would refuse to enforce that contract I am not aware of that situation I'm actually aware of some situations where federal courts have in fact enforced contracts I'm not aware of situations where federal courts except for bankruptcy courts have said no can't touch it it's illegal federally because at the end of the day whether you're in federal court or state court and even if you're in federal court the federal court is enforcing a contract that's governed by state law and under state law it's enforceable and it's legal but it's a great question I don't know if anyone else wants to chime in it's also assuming that your contract is legal and like it's between a legal licensed operator and another legal licensed operator if you are one or both of you are in a legal business that probably will be held and enforceable if you try to enforce that contract in state court there's a case called gullickson GU LOI C KS o n it's a Northern District of California so federal court case I think late 2016 but the northern district court basically said cannabis contract that's okay because it's based in California law there's a new law a year and a half cannabis contracts are lawful objects of Commerce in California they're like selling water in California he's right you want to stay out of federal court and just to correct the record when a corporation converts to an LLC that's when there's this asset sale type tax when an LLC converts to a corporation that's a smooth tax consequence drop and drop the mic lawyer correction disclaimer I would like to invite you to thank the panelists with me who did such a great job and imparted incredible [Music]