Cannabis Companies Prepare for Expensive Civil Litigation
It is common for businesses and individuals in the United States to resolve their disputes with lawsuits.
Unfortunately, the maturing cannabis industry appears to be like any other when it comes to this kind of dispute resolution. Participants increasingly are engaged in civil litigation involving:
1. Consumer-oriented claims, such as product liability, personal injury, and consumer fraud;
2. Commercial disagreements, such as claims for breach of contract in consulting agreements, insurance policies, or supply agreements;
3. Partnership claims, such as disputes over ownership interests and performance payouts;
4. Intellectual property claims, such as trademark infringement or trade secret/non-compete violations; and
5. Employment-related claims, such as COVID lay-offs, harassment, workers’ compensation, and wage-related claims.
While these types of lawsuits are common in most industries, because of the cannabis industry’s youth and the unique federal and state regulatory issues involved, businesses or consumers bringing, maintaining, or defending a civil action may be in uncharted waters.
There have yet to be any real precedent-setting cases to establish the playing field. Consequently, lawsuits may be more challenging for litigants, and thus potentially more disruptive and costly.
Some of the most high-profile cannabis legal proceedings to date have involved enforcement actions by federal and state government agencies, such as the Internal Revenue Service and state licensing bodies.
These types of proceedings, regulatory in nature, typically involve businesses interfacing with local, state, or federal agencies or administrators. They also normally involve novel questions of statutory and constitutional interpretation.
While they may require payment of regulatory penalties, forfeiture of a license or certification, or a change to the business structure, the objective of these types of actions is often a defined outcome. Depending on who initiates the action, the outcome may be removing (or securing) a permit suspension, nullifying (or imposing) a fine, or obtaining (or withholding) government approval.
In contrast, when a party embarks on or is roped into civil litigation, the remedy sought almost always is money damages and the amount is almost always uncertain until it is determined by the judge or jury—or between the parties in a settlement. The only certainty in civil litigation is that it is a distraction and a burden.
While a single aggrieved consumer might not seem like a big deal, that consumer could wind up being the canary in the coal mine.
As experienced trial lawyers who have litigated civil actions involving a number of different industries and who have focused on advising clients with a broad range of cannabis-related interests, we have set forth below examples of the intersection between civil litigation and cannabis, with a focus on tips for planning ahead to avoid or resolve quickly an otherwise resource-draining civil action.
Consumer-oriented claims
Consumer-oriented product claims arise when product consumption or use allegedly causes some type of injury. Frequently, the consumer (either alone or on behalf of a purported “class” of injured individuals) will claim the product suffers from some type of “defect.” Often, the suits charge the product was designed or manufactured in such a way that it was unreasonably dangerous to the end-user; sometimes litigants will argue the company failed to warn consumers about some known danger. Relatedly, consumer lawsuits, including consumer fraud actions, accuse businesses of misrepresenting their product, typically by falsely labeling, packaging, or advertising the product on a mass scale. Other suits in this category are based on the defendant company’s marketing tactics, even where they’re not (even allegedly) fraudulent or misleading. Consumer claims are common in all consumer-products industries—particularly the pharmaceutical, tobacco, and automotive industries.
Recently, the cannabis industry—albeit primarily in the hemp space—has seen an uptick in product-liability-related and consumer-oriented cases. For instance:
Ellis v. RK Endeavor, a truck driver claimed he purchased a bottle of CBD oil that, unbeknownst to him, actually contained THC. Later, allegedly, he was fired because a drug test detected THC in his system.
Darrow v. Just Brands USA, another truck driver, alleged “JustCBD” watermelon rings caused him to test positive for THC, even though the labels advised “No THC,” resulting in his termination.
Snyder v. Green Roads, a CBD products manufacturer was sued in federal court in a proposed class action for allegedly selling infused gummies, tea, and oil with concentrations of CBD different from the amount advertised.
Highlighting the fact courts are grappling with how to deal with many cannabis-related issues, the judge in Snyder decided to stay the case pending development of federal regulations concerning the use of CBD in consumer products.
Some consumers have used the hazy federal regulatory landscape to their advantage, filing putative class actions against a number of CBD product manufacturers including Charlotte’s Web and CV Sciences, arguing the companies’ sale of CBD-infused ingestible products (such as dietary supplements and gummies) is simply illegal under the Federal Food, Drug, and Cosmetic Act, echoing the position taken by the U.S. Food & Drug Administration in recent warning letters.
Other putative class actions filed in federal court have relied on alleged violations of different federal laws to target businesses in the cannabis industry. In Williams v. Eaze Solutions, for instance, the plaintiff argued Eaze—which operates a mobile application to facilitate the delivery of cannabis products from dispensaries to consumers—violated the Telephone Consumer Protection Act (TCPA) by sending repeated, unsolicited text messages. Eaze argued the case did not belong in court, as the plaintiff—when she signed up for the app—agreed to a mandatory arbitration provision. The plaintiff countered that because the object of the agreement was marijuana (illegal under federal law), no contract was formed. The court ruled that even though the contract’s object was marijuana and the contract was thus void and unenforceable, it had still been formed. Because it found the Federal Arbitration Act applied and the contract required arbitration of gatekeeping issues of arbitrability, the court found in favor of Eaze, requiring arbitration under the contract even though it simultaneously found the agreement could be unenforceable if a court ultimately found its object was unlawful.
Reflecting yet another sort of consumer-type action, a number of CBD companies selling their products online have been sued in putative class actions under the Americans with Disabilities Act (ADA) on the grounds their websites are not accessible to blind customers.
While most of the product liability and consumer fraud litigation has taken place in the hemp industry, the marijuana market has not been entirely immune. In Wilcoxen v. Canna Brand Solutions LLC, filed in the wake of the vaporizer/e-cigarette lung illness outbreak, the plaintiff alleged manufacturers of THC vaporizer accessories had produced and sold defective products, leading to the consumer’s injuries.
These cases and others like them present several takeaways. First, cannabis operators (cultivators, manufacturers, distributors, and retailers) and ancillary businesses who cater to them should take quality control (QC) seriously. Implementing QC and compliance policies, including strict adherence to safety standards and required testing protocols, can mitigate the risk of selling products that do not comply with the law or reflect what’s stated on the package or label. Because the national cannabis regulatory framework is a patchwork of varying state laws and regulations, many of which are in contravention of federal laws and regulations, businesses must pay close attention to the specific requirements not only of the states where they’re producing products, but also of the states in which they intend to sell the products to end-users. In addition, businesses would be wise to take consumer complaints seriously. As product liability and consumer products litigators know, while a single aggrieved consumer might not seem like a big deal, that consumer could wind up being the canary in the coal mine—a signal of an impending wave of litigation.
Some of the most high-profile cannabis legal proceedings to date have involved enforcement actions by federal and state government agencies.
In most consumer-oriented product claims, there won’t be a contract governing the relationship between the manufacturer and the end-user. But in consumer cases involving situations where agreements do control, such as in the Eaze case, businesses should give serious thought not only to the content of dispute resolution provisions, but also to the choice of law or venue provisions. It’s unclear, for example, whether Eaze’s argument in favor of arbitration would have fared as well as it did were the case heard in another jurisdiction.
In addition, given the increasing prevalence of ADA lawsuits brought against cannabis companies, businesses need to keep in mind they are subject to the laws and regulations generally applicable to businesses regardless of industry. As such, while ensuring compliance with cannabis- and product-related rules is critical, operators should not overlook the importance of adhering to more “standard” types of business regulations.
Finally, it’s also a good idea for companies operating in the cannabis space—like those in any other consumer-facing industry—to maintain adequate lines of product liability insurance to help mitigate the costs of expensive litigation in the event a lawsuit develops. While it may be relatively difficult for marijuana businesses to find insurers who are ready, willing, and able to work with them, identifying such insurers could prove invaluable. In some cases, having adequate insurance can mean the difference between solvency and bankruptcy.
Commercial contract disputes
All industries are dependent on commercial relationships, such as arrangements between firms regarding product development, supply and distribution, and sales and marketing. Not surprisingly, commercial contract disputes represent a substantial portion of civil litigation in this country. The cannabis industry is sure to continue to experience a growing number of commercial lawsuits.
In Mann v. Gullickson, a company claimed it was due money under an agreement pursuant to which it provided consulting services to marijuana businesses. The defendant argued the federal court hearing the case should refuse to enforce the consulting agreement on the grounds marijuana is illegal under federal law. The court denied the defendant’s motion for summary judgment, writing that it could grant the relief sought in the case without requiring either party to violate federal law: “[M]andating… payment does not require Gullickson to possess, cultivate, or distribute marijuana, or to in any other way require her to violate the [Controlled Substances Act (CSA)].” The state court in Green Cross Medical Inc. v. Gally reached a similar result but for a different reason. In that case, a medical marijuana dispensary operator sued its landlord for breach of the lease agreement; the landlord argued the lease was illegal and was thus unenforceable. However, the court disagreed, holding that although marijuana is illegal under the CSA, Arizona (where the case was pending) had passed a medical marijuana law and the Department of Justice was prohibited from prosecuting individuals compliant with state medical marijuana laws. Green Earth Wellness Ctr. LLC v. Atain Specialty Insurance Co. concerned enforcement of an insurance contract where the insured product was marijuana. After the insurer denied the claim, arguing the contract was void because its insured could not have an “insurable interest” in federally illegal marijuana, the insured sued. The federal court rejected the insurer’s defense, noting federal marijuana regulation has undergone substantial changes in recent years and holding an insurer who knowingly insures marijuana cannot later escape its obligations under the agreement by asserting the illegality defense.
What may be the most noteworthy about the cases discussed above is what’s unremarkable about them: In each of the three cases (two federal and one state), the court did not abstain from enforcing the parties’ contractual obligations solely because the contract at issue pertained to marijuana. While parties may want to include provisions restricting the ability to invoke the federal illegality defense as an added layer of protection, a key takeaway from the cases explored above is, as a general proposition and with a number of caveats, it appears as though courts have been willing to entertain contractual disputes concerning marijuana businesses. The relevant caveats are 1) the cases described in this section have been decided by courts in states that have legalized marijuana in one form or another, and 2) the parties in these cases did not seek a remedy that would require a court to order violation of the CSA. Given the second caveat in particular, parties instituting lawsuits or counter-claiming against a plaintiff may want to seek remedies in the form of monetary payments rather than shares in a business, because, as we explore below, courts have shown a reluctance to grant the latter type of relief in marijuana-related cases. Finally, deals among businesses are generally governed by agreements; as such, in these types of situations, companies are given the opportunity to take prophylactic measures (such as crafting provisions on dispute resolution, choice of law, and venue) that are unavailable in the absence of a contractual relationship.
Partnership disputes
Partnership disputes can be particularly contentious in the cannabis industry. In the nascent industry where licenses are highly coveted and hard to come by, individuals and businesses have been willing to invest in litigation as a means of securing their proverbial piece of the pie. Plaintiffs in these sorts of rows, as in other industries, may seek a variety of remedies, from an award of monetary damages to an order requiring the transfer of a particular ownership interest from one to another.
In Polk v. Gontmakher, an individual claiming entitlement to an equity share in a marijuana operation sought a court order granting him that equity stake. Explaining a federal court cannot grant a remedy that, in effect, mandates illegal conduct, the court dismissed the complaint. (Compare this result to the one in Gullickson, in which the party sought relief in the form of payment and the case was not dismissed.) In Left Coast Ventures Inc. v. Bill’s Nursery Inc., the same federal district court addressed a contract dispute as to the rights to a licensed medical marijuana facility in Florida. The court issued an order to show cause why the case should not be dismissed on the grounds that, as stated in Polk, awarding interest in a marijuana entity would be mandating illegal conduct. While the defendant argued that the court could not enforce the contract because marijuana is illegal, the plaintiff argued, among other things, that deciding the case would entail simply enforcing a routine contract and public policy favors enforcement of contractual agreements. The court ultimately decided not to dismiss the suit but to abstain from deciding the issue because of the primacy of state law concerning the subject matter of the contract. As such, the case was sent back to state court.
Whereas patents generally expire after twenty years, trademark protection can last for a potentially unlimited amount of time.
A couple of noteworthy lessons emerge from a review of Polk and Left Coast Ventures. First, in drafting partnership agreements (and, as discussed above, commercial contracts more generally), parties may want to carefully specify approved methods of dispute resolution and the governing choice of law or venue; in addition, they may want to require that all parties waive the right to invoke certain bases for dismissal—including the current treatment of marijuana under federal law. However, on the latter, this may go only so far.
Case law has shown courts’ willingness to sua sponte consider the issue of federal illegality in determining whether consideration of the matter is proper. Additionally, while the decisions of one federal district court certainly do not amount to precedent, the type of remedies sought appears to matter. Where the relief requested is a share in a marijuana business, courts have appeared wary to take up the case for fear awarding such relief itself could be a violation of federal law. In contrast, a breach of contract suit seeking purely monetary damages would not, under the cases explored above, register the same issue, perhaps presenting a more viable alternative to a litigant hoping to survive a defense rooted in the illegality argument.
Intellectual property infringement
Common types of intellectual property (IP)-related disputes involve claims of patent infringement, copyright infringement, and trademark infringement. While patents and copyrights are within the exclusive domain of federal law, claims may be brought for trademark infringement under federal or state law. Also unique to the realm of trademarks is products for which trademark protection are sought must be lawful under federal law. Currently, that would not include marijuana products.
KIVA Health Brands v. KIVA Brands involved a dispute over rights to the name “KIVA” between a health foods company (Kiva Health) and a marijuana-infused edibles company (Kiva Brands, or KBI). Although Kiva Health initiated the lawsuit, KBI countered with its own claims, among them that KIVA Health’s registered trademark should be canceled and, under the federal Lanham Act, KIVA Health actually infringed KBI’s marks, which had been used before KIVA Health’s. KIVA Health moved to dismiss the counterclaims, arguing KBI’s manufacture and sale of federally unlawful products rendered it unable to maintain the claims.
The court agreed. In a ruling issued late last year, the court explained “[t]o hold that KBI’s prior use of the KIVA mark on a product that is illegal under federal law is a legitimate defense to KHB’s federal trademark would ‘put the government in the anomalous position of extending the benefits of trademark protection to a seller based upon actions the seller took in violation of that government’s own laws.’” (In a similar case, Woodstock Ventures LC, et al. v. Woodstock Products Co. International Inc., et al., SDNY 1:18-cv-01840-RWS, a team of Duane Morris lawyers led by Seth Goldberg represented a cannabis-infused products manufacturer in a trademark infringement lawsuit brought by the founders of the Woodstock Music & Arts Festival of 1969 concerning the rights to the “WOODSTOCK” trademark in connection with cannabis-related products.)
Another trademark case recently decided in federal court further illustrates the branding complications posed by the treatment of marijuana under federal law. In Tapatio Foods, LLC v. Arfarh, Tapatio Foods accused the alleged makers of Tiowaxy THC medicated hot sauce of diluting Tapatio’s brand name. Arguing that Tiowaxy sounds similar to Tapatio and that the products share a similar font and label designs, Tapatio asserted that its brand had been tarnished due to its association with the defendant’s product, infused with a Schedule I controlled substance. Ultimately, the court granted a permanent injunction in favor of Tapatio, though that ruling was predicated on the defendant’s default in the litigation.
The KIVA ruling suggests a hostility, at least on the part of one federal court, toward trademark claims based on conduct that is unlawful under federal law. As such, this may incentivize cannabis businesses to pursue trademark claims under state law, rather than federal, to avoid the result in KIVA. (It is unclear whether the result in KIVA could be expected in a patent dispute rather than a trademark case, as there is no “lawful use” requirement for patent eligibility as there is for trademark protection under the Lanham Act.) The KIVA case also demonstrates IP rights in the cannabis industry—as in other consumer product markets—can be incredibly valuable. Whereas patents generally expire after twenty years, trademark protection can last for a potentially unlimited amount of time. As such, cannabis businesses should invest in protecting their IP while remaining cognizant of certain courts’ and jurisdictions’ wariness of rewarding conduct that violates federal law. Firms should also recognize that potentially infringing behavior may lead not only to a lawsuit claiming trademark infringement or unfair competition—a plaintiff might also seek to capitalize on the fact marijuana (and THC) is illegal under federal law, as the plaintiff did in Tapatio, to support a theory their brand has been tarnished or its value diminished.
Employment
The potential for employment-related legal issues exists in every workplace, from the potential for race discrimination or sexual harassment suits under federal or state law to wage-related claims under the Fair Labor Standards Act (FLSA) or its state-law equivalent. As businesses with employees, companies operating in the cannabis space are not immune from these sorts of issues and they have begun to face these sorts of claims.
One significant case shines a light on the intersection of federal employment law and business illegal under federal law. In Kenney v. Helix TCS, the plaintiff sued his employer (Helix), a company that provides security services to businesses in the marijuana industry. The crux of the case was Helix classified Kenney as an “exempt” employee, meaning he was not eligible for overtime pay. Kenney’s suit argued he should not have been so classified and was owed overtime under the FLSA. Helix argued Kenney was not entitled to the protections of the FLSA because marijuana—the industry in which Helix operates—is unlawful under federal law. A federal appellate court disagreed, stating in no uncertain terms “employers are not excused from complying with federal laws just because their business practices are federally prohibited.”
A primary takeaway from Helix is companies in the cannabis industry, like those in any other industry, should develop and implement procedures to ensure compliance with all state and federal employment regulations (including those implemented under the FLSA). The Helix case confirms the “federal illegality” defense has its limits; as with tax cases concerning the application of Internal Revenue Code § 280E to cannabis businesses, the fact marijuana is federally illegal will not protect employers who otherwise run afoul of federal law in operating their businesses. This case, like the contract dispute cases discussed above, demonstrates legal obligations may not simply be ignored on the grounds they concern marijuana. Given this reality, making compliance a pillar of a company’s business plan can help mitigate the risk of costly litigation.
Conclusion
They say, “you don’t know what you don’t know.” In the world of civil litigation involving the very young cannabis industry, the laws are still developing, so there are unknowns. As evidenced by the spike in cannabis-related litigation in 2019, and as the industry matures it seems like it may mirror most other U.S. industries in the sense participants will resolve disputes with litigation. Counsel experienced in both civil litigation and cannabis-specific issues such as the federal/state conflict and state-by-state patchwork of cannabis regulations (and therefore not needing to be “brought up to speed”) will be essential to guiding litigants to cost-effective resolutions. However, planning ahead by incorporating some of the tips set forth above—especially those relating to internal practices and procedures concerning federal and state regulatory compliance—could reduce the time and expense of a cannabis-related civil action.
By Seth A. Goldberg Esq. and Justin M. L. Stern Esq.
