What Landlords and Cannabis Operators Need to Consider When Negotiating a Lease

The cannabis industry has been expanding at a rapid rate nationwide for a number of years now. As of January, 24 states have legalized cannabis for recreational use and that number is likely to grow over the next few years. With rapid expansion comes the need for spaces where cannabis businesses can operate. While some operators are in a position to purchase property, many who are starting or expanding their businesses will need to lease that space from commercial landlords.

Unlike in standard leasing transactions, both landlords and tenants must take into account a number of additional considerations when the space in question will be used for a cannabis business.

Local Land Use Regulations

While certain states have passed laws legalizing medical or recreational cannabis (or both), it is often local municipalities that govern how those laws are interpreted on the ground through land use regulations.

Such regulations can contain requirements, restrictions or outright prohibitions related to cannabis. Requirements and restrictions can include, but not be limited to, required distances from certain properties, such as schools, daycare centers, public parks or recreation facilities); limits on where cannabis can be used within the municipality, such as certain commercial or industrial zones; set hours of operation; and restrictions on the size and design of building signage related to the cannabis use.

Both landlords and tenants should work with legal counsel to understand local land use regulations that affect cannabis before entering into a lease to ensure a successful transaction.

Considerations for Landlords

• Understanding Financial Covenants. Landlords need to determine if existing loan covenants will be violated by entering into a lease for cannabis use. While some lenders have started entertaining the idea of cannabis use leases, most financing documents will contain covenants that require a landlord to comply with all local, state and federal laws. An issue may arise as cannabis, or marijuana, is still designated as a Schedule I drug under Title II of the Controlled Substances Act. Prior to entering into a cannabis use lease, a landlord should seek counsel from its lenders and legal counsel.

• Buildout Requirements. State statutes and local municipal regulations will likely contain mandated buildout requirements for a cannabis use. These improvements can include, but not be limited to, heightened security requirements — such as cameras, alarm systems, security doors, fencing and gates — lighting requirements, the installation of a vault, and buildout requirements surrounding the storage and disposal of cannabis waste. In an attempt to avoid potential issues, landlords should require that a comprehensive work letter be included as part of the cannabis use lease. Further, as mandated buildout requirements will likely be required outside of the actual cannabis use premises, landlords should require prior written approval of all plans and specifications.

• Payment of Rent. Pursuant to the Bank Secrecy Act, it is considered a crime for a bank to engage in transactions involving money which is knowingly derived from illegal business activity. Since cannabis is still designated as a Schedule I drug under the Controlled Substances Act, many local and national banking institutions are reluctant to provide banking services to landlords who collect rent from cannabis use tenants. Prior to entering into a cannabis use lease, a landlord should review the policies of its current bank to determine if cannabis use rents can be deposited. Landlords should also review their financing documents as many lenders require all monies derived from a property to be deposited into an account established with the lender.

Considerations for Tenants

• Licensing Contingency. Many states require that a tenant show "site control," meaning a fully executed lease must be submitted as part of the licensing process. This puts cannabis operators in an uncomfortable position as they must sign a binding agreement with a landlord prior to the issuance of a license. Cannabis use tenants should negotiate for a licensing contingency to allow for termination of the lease in the event a license is not issued. A cannabis use tenant can propose a one-time termination payment to provide the landlord with an incentive to enter into the lease knowing it may be terminated.

• Permitted Use. Cannabis use tenants should attempt to be specific when crafting a "permitted use" for inclusion in a lease, but also allow for different uses in the future as the cannabis market is ever-changing. At the very least, the lease should specifically state if the space will be used for retail, cultivation or cannabis manufacturing, but also include the right to change the use with the prior approval of the landlord, with such approval not being unreasonably withheld, conditioned or delayed. An example of a situation where an operator may want to change the use of the space is if a state were to amend its regulations to allow for both the cultivation of cannabis and manufacturing of cannabis products under one license.

• Landlord Access to Premises. Under a traditional lease, a landlord would require the right to access the premises upon advance notice or immediately in the event of an emergency. In contrast, many states and local municipalities require restricted access to the entire premises, or in some cases certain portions of the premises, which house a cannabis operation. A tenant should work with legal counsel to help educate landlords on this restricted access requirement. A cannabis use lease should cite directly to applicable statutes or regulations so there is no confusion between the parties.

These considerations are the baseline for a business relationship that is able to thrive in the evolving environment of legal cannabis. With clear agreements and collaboration between landlords, tenants and legal advisors, operators and property owners can establish a secure foundation for their leasing relationships, helping both parties mitigate risks and meet industry requirements.

Christopher M. Rousseau is an attorney in the Real Estate, Energy, Environmental and Land Use practice at the law firm Pullman & Comley with offices in Connecticut, Massachusetts, Rhode Island and New York.