Ownership and Financing of Cannabis Businesses: The True Party of Interest
Cannabis industry insiders recently learned the Washington State Liquor and Cannabis Board (WSLCB) is considering implementing a “Hidden Ownership Amnesty Program” that would allow cannabis businesses to come into compliance with ownership and financing regulations without fear of license revocation. In this article, we dive deeper into what ownership and financing regulations exist in Washington and how true party of interest regulations impact cannabis businesses.
I. Ownership Regulations in Washington
All Washington State marijuana licenses must be issued in the name (or names) of the true party (or parties) of interest of the cannabis business. A “true party of interest,” as defined in Washington Administrative Code section 314-55-035, is a person who owns, participates in the management of, or otherwise receives a percentage of profits in exchange for a monetary loan or in exchange for their expertise with respect to a cannabis business. True parties of interest are held responsible for the conduct of the business, and must undergo a financial investigation, criminal and civil background investigation, interviews, fingerprinting, and other requirements in order to successfully pass WSLCB vetting requirements and be eligible for licensure. These rules apply to new applicants and applications, as well as to an application for transfer or assumption of an existing license. Violation of these rules constitutes a “Group 3 License Violation” and carries a penalty of license cancellation upon the first instance – the harshest penalty available under the Code.
For example, if a person in their individual capacity or as a sole proprietorship applies for a license, that person and their spouse will be considered “true parties of interest” under the Code. If a privately held corporation, an LLC for example, applies for a cannabis license in Washington State, all corporate officers and stockholders, as well as their spouses, are considered “true parties of interest.” Further, a party can become or be considered a “true party of interest,” even unintentionally, if he or she exercises “any control over the applicant’s business operations.” (WAC 314-55-035(4))
Financiers, or investors, in cannabis businesses will not be considered “true parties of interest” under the Code so long as they do not share in the profits of the business or exercise control over the business. Financiers are still required to undergo a financial investigation as well as a criminal background investigation in order for the WSLCB to permit the party to finance the cannabis company.
II. Residency Requirements
Washington law imposes strict residency requirements on owners, operators, and investors in licensed marijuana businesses.
First, all prospective licensee entities (such as an LLC or a partnership) must be formed in Washington State. Further, all prospective owners and operators of that entity, as well as their spouses, must demonstrate residency in Washington State for six months prior to submitting their application for business ownership. This means that, whether the prospective licensee is a single person, a partnership, cooperative, association, nonprofit, privately held corporation, or any other business entity, every single member must meet the six-month residency requirement. Additionally, licensees must maintain such residency in order to remain in compliance with the WAC.
On the other hand, prospective investors in a marijuana business – otherwise known as “financiers” in Washington – need not meet these residency requirements. However, even resident financiers cannot cannot share in profits from the business nor are they permitted to exercise control over the operations of the business. Further, non-resident financiers are limited to receiving only a basic return on investment, as if they have given a personal loan to the company.
A violation of these rules constitutes a Group 3 License Violation under WAC 314-55-530, and carries the penalty of license cancellation upon the first occurrence of such a violation.
III. Vetted People
All true parties of interest with respect to a marijuana license are required to submit to a criminal background investigation in order to determine whether he or she is qualified for licensure. The WSLCB imposes a point system when evaluating an applicant’s criminal history based on the types and number of convictions he or she previously suffered, as well as the date of the crime. A sufficient number of points – more than 8 (eight) – may prohibit an applicant from obtaining a cannabis license.
True parties of interest are also subject to a limited civil-wrong background investigation. In Washington State, the WSLCB conducts an investigation of an applicant’s marijuana law or administrative violation history. The WSLCB will not issue a license to a person or entity that has committed the following infractions:The WSLCB makes a variety of enhancements and exceptions to these basic rules, reproduced in the chart above. For example, up to two federal or state misdemeanor convictions for possession (only) of marijuana in the three-year period prior to the application “may not be applicable to the criminal history points accumulated.” (WAC 314-55-040(3)(a)) On the other hand, an applicant’s failure to disclose their full criminal history will result in additional point accumulation.
IV. Vetted Money
The wrongful addition of a “true party of interest” to a cannabis business – even unintentionally by, for example, vesting control of the business operations in a person the business incorrectly considers a mere employee – constitutes a Group 3 License Violation under WAC 314-55-530, and carries the penalty of license cancellation upon the first occurrence of such a violation.
Prior to licensure, the WSLCB will conduct a financial investigation in order to verify the source of funds used for the acquisition and startup of the business, as well as the applicants’ right to the real and personal property to be used by the business. (WAC 314-55-020(7)) After licensure, all true parties of interest, including financiers, must continue to disclose the source of funds for all money invested in the licensed business. The WSLCB, through it’s investigation, must be able to determine that the funds identified by the applicant to be used in the acquisition, startup, and operation of the business is verifiable, unquestionable, or otherwise determined to have been gained lawfully. (WAC 314-55-050(6)) Violations of these requirements, or failure to disclose such facts fully and truthfully, can result in license denial, suspension, or cancellation.
V. Violations of Ownership and Financing Laws
A study of licensing trends reveals that license cancellation is recommended in less than fourteen percent of first-time violations across all five categories of contemplated violations under Washington law. It is reserved as the most severe punishment for the most harmful or dangerous infractions and licensees who pose the greatest threat to the State’s marijuana regulatory system. Group 3 Licensing Violations, including ownership and financing violations, fall under this category in Washington State.
True Party of Interest violations may take a wide variety of forms. The WSLCB has discretion with respect to the assessment and imposition of penalties, but that means the WSLCB also has the authority to cancel business licenses even for minor infractions – and they have consistently done so in recent years. Even minor infractions can result in prosecution and license cancellation. More egregious violations that almost always result in filing for license cancellation include activity such as the acceptance of large sums of undisclosed cash, distributing profits to an undisclosed owner or financier, or failing to honestly disclose startup costs.
Important to any licensee or cannabis entrepreneur is the knowledge that, while these code violations carry a penalty of license cancellation, “Based on mitigating circumstances, the WSLCB may offer a monetary option in lieu of suspension, or alternate penalty.” (WAC 314-55-515(5).)
VI. WSLCB Discretion
The WSLCB is granted broad discretionary authority in assessing penalties for cannabis rule violations (WAC 314-55-515(5); see also WAC 315-55-110(2)). The Board is empowered to consider mitigating and aggravating factors, and impose a penalty different than that outlined in the guidelines, tailored to the circumstances of the case, including “a monetary option in lieu of suspension, or alternate penalty.” (WAC 314-55-515(5).)
The policy behind the “true party of interest” regulation was arguably two-fold: First, to ensure that no out-of-state money entered the market; second, to prevent the establishment of vertically integrated and criminally prone enterprises.
With respect to the first consideration, preventing out-of-state money from entering the market, the architects of I-502 knew that in order to create a successful recreational market, a large contingency of the state’s black and medical marijuana markets would need to be folded into the new regulated system. Preventing well-funded out-of-state money and owners from entering the market allowed the new Washington State recreational system to co-opt the biggest local competitors.
Secondly, there was concern that drug cartel money and tied-houses would predominate the market and undermine I-502. By assuring that money only enters the state’s marijuana market from Washington State residents, by implementing an extensive application and vetting process that involves forensically accounting for all money coming into the market through I-502, the WSLCB assures that only local, clean money – that is, not related to criminal enterprises and is not vertically integrated among producers and processors – flows through the state’s recreational market. This both encourages a robust foundation of local participants, and also discourages monopolies and organized crime.
In imposing the state’s current true party of interest rules and regulations regarding such ownership and financing requirements, the WSLCB is empowered to consider mitigating and aggravating factors, and impose a penalty different than that outlined in the guidelines, tailored to the circumstances of the case, including “a monetary option in lieu of suspension, or alternate penalty.” (WAC 314-55-515(5).)
A. Mitigating Factors
In many cases, such as in the examples included in section II of this article, licensees may have violated the black letter of the true party of interest Code, but have complied with the spirit of the law and also pose none of the threats that the “true party of interest” regulations were designed to prevent or punish. As a result, in such cases, penalties short of license cancellation is appropriate.
Indeed, a “fewer days of suspension and/or a lower monetary option” is expressly authorized by the Code in lieu of license suspension or cancellation when mitigating factors are present. For example, when a rule violator accepts responsibility for his or her actions, signs an acknowledgment assuring his or her future responsible handling of business transactions, or demonstrates the implementation of new business policies and practices that reduce the risk of future violations, a lesser penalty is recommended by the Code. (WAC 314-55-515(5)(a))
B. Aggravating Factors
On the other hand, aggravating factors that can result in consequences such as an increase in the number of days a license is subject to suspension, an “increased monetary option,” or even imposing the penalty of license cancellation where the code does not expressly authorize that penalty include the licensee posing an increased risk for future violations, the licensee incurring multiple violations within a three-year window, or the licensee participating in criminal activities such as money laundering, organized crime, and involvement with firearms (WAC 314-55-515(5)(b)).
VII. Responding to Ownership and Financing Violation Notices
We acknowledge that license cancellation is a valid consequence for more extreme, harmful, or dangerous violations of marijuana business laws, including licensing regulations, however the standard penalties outlined in the Washington Administrative Code were originally meant to serve only as guidelines and should be modified to allow for a standard penalty short of license cancellation with respect to minor ownership or financier infractions, so that cannabis businesses are empowered to operate openly and honestly with the WSLCB. (WAC 314-55-515(5))
A proper legal analysis of the issues comprising any Ownership or Financier AVN, and persuasive presentation of the relevant mitigating facts and circumstances to the Attorney General or a Judge (or Commissioner) assigned to a case – including the independent discovery of error, prompt and complete remedial measures taken by the licensee in advance of the issuance of the Administrative Violation Notice, as well as the licensee’s full availment to and demonstrated transparency throughout the licensing process and subsequent investigations of the WSLCB – may successfully demonstrate that a lesser penalty, short of license cancellation, is appropriate in a particular case alleging a true party of interest violation – offering hope to businesses who desire to come into compliance despite making a previous mistake or, perhaps, even engaging in de minimis wrongdoing – even if the WSLCB never implements the proposed “Amnesty Program.”