Mistakes in Commercial Cannabis Sales in Oregon: Part 2

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We’ve been helping people buy and sell Oregon cannabis businesses since the early days of the adult use market. Most of these sales are relatively straightforward asset purchase deals – many for bare licenses – but some have been stock sales. Others have occurred under administrative enforcement actions taken by the Oregon Alcohol and Cannabis Commission (OLCC).

This is the second of two articles about common mistakes we see in Oregon cannabis sales. Last week, I covered lazy diligence, sleeping on inventory, service agreements, and unclear timelines. Today, I have five more risks for you: sales structure, landlord issues, local issues, earnest money, and escrow issues.

Sale structure (asset or stock sale agreement)

Story time. We represented a minority shareholder in a recent sale where the company accepted a sale of assets (full liquidation) of an OLCC licensed vertical from a C-corp. When alerted to the potential tax impact, the selling lawyers felt that C-corp “was not well managed and there were outstanding debts”. It appears that no consideration was given to what could be accomplished in a standard pre-closing window, as well as standard options for closing conditions, indemnity escrows, ticket set-off rights to order for the buyer and other types of deductions. A seller may also negotiate with a buyer the liability for various liabilities during due diligence, in which case the parties may negotiate related representations and warranties, indemnities, etc.

The point here is that not all Oregon cannabis businesses are LLCs taxed as partnerships, and not all sales should be asset sales. Still, I’d be surprised if I didn’t come across a few other instances over the next 12 months similar to the story above, where a selling C-corp accepts a proposal to buy assets (as in the total liquidation of company) simply because the buyer suggests it. “That’s how these companies are sold,” people sometimes say. “It was the best offer.” Etc. Unfortunately, sellers – and even their advisors – often don’t understand the tax implications associated with selling anything but shares of a company. A likely consequence: too many taxes.

So why do C-corp companies generally prefer stock sales? First, the proceeds will be taxed at capital gains rates rather than ordinary tax rates. When selling a C corporation, corporate level taxes are circumvented by a stock sale. Selling shareholders can also achieve the incredibly valuable exclusion of qualified small businesses if the shares have been held for five years and other criteria are met. Finally, the selling company and its shareholders can obtain liability protection in a stock sale by getting rid of their known and unknown liabilities, at least those that they do not agree to retain.

Blindly preying on an asset sale in every cannabis business transaction is not the way to go. Speak to a CPA who specializes in cannabis before agreeing to a sales structure, including the breakdown of the purchase price, if applicable, especially if you are a seller. I hate seeing people pay too much tax.

Owner issues

The owners are an interesting lot. By this I mean owners of small commercial buildings – especially marginal buildings, and especially landlords willing to rent out to cannabis operators – can be difficult to manage. Griffen Thorne of our Los Angeles office has written extensively about this dynamic. See here, here and here.

When someone buys a cannabis business, they often have to accept an assignment of lease from the vendor or negotiate a replacement lease with the vendor’s landlord. Owner consent is usually required in the first scenario, and always in the second.

Some landlords have little incentive to work with a buyer, especially if things have gone well with the current tenant. Many landlords also insist on using unsuitable leases, often cobbled together without advice from unsuitable forms. The owner used this form with the seller, after all, and nothing serious happened. In my opinion, it’s like riding a bike with a cracked helmet, because you’ve always used that helmet, and a new one is expensive, and you’ll probably never have an accident.

Either way, it’s very important for Oregon cannabis sellers to make sure their owner will work with them, to the extent required, before signing a term sheet. And it’s important for buyers to check out the tenancy and ownership aspects of a property as early as possible. This is one of the issues where transparency and cooperation between the parties are essential, in order to reach an agreement.

Local issues

Local issues can be troublesome in cannabis sales in Oregon. I’m not just talking about land use compatibility declarations or unnecessary local licensing programs. When the sale of a business involves real estate (real estate), a number of things can come up, especially in a place like the city of Portland. I’ve seen state and local agencies require all kinds of improvements and concessions associated with changes in use or real estate ownership, for example: six-figure curb cuts, easement requirements, or warrants to add vehicular access points to a given plot.

Some of these requirements may be due to the nature of a good’s use (cannabis, cannabis retail, cannabis processing, etc.), while others may arise from regulations or policies enacted after the last change of hands of a plot. It’s unfortunate, however, when a surprise like this surfaces in a deal, especially after a portion of the purchase price has become firm, or a buyer has made other binding commitments. This brings me to the next topic.

serious money problems

I like deposits in transactions, even if it’s fully or partially refundable, and even if it’s just in the form of a promissory note or something similar. People should have their skin in the game. The problem with many Oregon cannabis sales agreements, however, is that they lack basic parameters regarding deposits. Most purchase contracts aren’t standard forms, after all, and deposits are often something that gets stuffed along the way.

Another story. Last month, someone returned to us an underlined draft of a purchase agreement where no deposit was required to get started (the letter of intent did not contemplate it in this case). The seller’s attorney added a line that read “The buyer will provide the seller with a $20,000 deposit upon signing of this agreement, which will serve as a credit against the purchase price at closing.” There were no instructions for the deposit, let alone anything on how or if the deposit money would be refundable, or when it would ‘go hard’. What if the seller violated the agreement? What happens if the buyer has committed a violation? What if the landlord refuses a lease assignment? What if the OLCC refuses to grant a license because of such violation or that? Etc. Whenever money goes over the back board, if and when it can come back, if at all, should be very clear.

Escrow issues

There are a few issues around escrow that make Oregon cannabis deals attractive. First, in the real estate context, it is always impossible to find a title company that will serve as the receiver for a transaction. (It’s hard enough to find one that extends a title policy.) I think I first wrote about this six years ago and not much has changed. This means cannabis buyers and sellers must find a different type of agent. And that escrow agent shouldn’t be one of the party’s attorneys absent special circumstances – which is another mistake we often see.

Over the years, we have always worked with third-party escrows that are not title companies in cannabis asset purchases, stock purchases, and real estate transactions. These agents tend to plan their fees on the title company’s calculators for real estate transactions and may agree to pay a business sale agreement. Escrow is affordable either way, and most transactions must go through escrow, at least in part, as part of a standard escrow agreement.

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Let us know in the comments if you see these or other common errors in Oregon cannabis sales. Or feel free to email me with thoughts. Until then, may all your transactions close quickly and stress-free.

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