Nevada Federal Court Throws Enforceability of Cannabis-Related Contracts into Doubt

Federal courts have increasingly ruled on disputes arising out of the cannabis industry or applied federal statutes to cannabis-related matters. There is a strong trend toward the enforcement of contracts and other rights of cannabis industry litigants in federal court.

An order entered in April 2020 by the Nevada District Court, however, raises concerns because the court refused to enforce a loan agreement that was legal under Nevada state law on the basis that it violates the Controlled Substances Act (CSA).

Bart Street III v. ACC Enterprises LLC, et al. arises from the defendant’s alleged breach of a multimillion-dollar loan contract to finance the expansion of the defendant’s marijuana cultivation business in Nevada. A portion of the loaned amount was earmarked toward operating capital and plaintiff was granted a first right of refusal to obtain shares in the defendant’s entities. When the defendants failed to repay the loans, plaintiff sued in the Nevada District Court for breach of contract and unjust enrichment. The defendants argued that they could not be held liable for breach of a contract that is illegal under the CSA.

In an Order dated April 1, 2020, the federal court refused to enforce the contract by finding that the right of first refusal and operating capital terms violated the CSA because the right of first refusal term would have allowed the plaintiff to profit from the sale of marijuana, and the operating capital provision provided direct assistance to the defendants’ cultivation of marijuana. The court further noted that it is irrelevant that marijuana is legal under Nevada state law because the CSA preempts Nevada law under the Constitution’s Supremacy Clause.

The court also rejected the plaintiff’s claim for unjust enrichment, noting that allowing recovery for unjust enrichment “would undermine enforcement of federal law by giving prospective investors increased confidence in funding marijuana businesses.” The court further rejected the unjust enrichment claim on the basis that the parties’ contract involves “moral turpitude.” Apparently anticipating a negative public reaction to this conclusion, the court took the precaution of explaining that “it is not the job of the court to weigh the policy considerations behind federal marijuana prohibition against Nevada law and the growing trend of state ‘legalization.’”

The Takeaway
One should understand the difference between how federal agencies and the federal courts are responding to the growth of state commercial cannabis markets. Federal policy regarding enforcement of the CSA has shown ambivalence where the possession and distribution of marijuana is consistent with well-regulated state law. Some federal courts, however, take a nuanced but strict position with respect to enforcement of cannabis-related contracts and other rights by evaluating whether enforcement would require the litigant to actively violate the CSA.

For example, various federal courts have enforced cannabis-related contracts pertaining to insurance, federal labor and employment statutes, federal intellectual property protections, and contracts around ancillary products and services. In those cases, the courts determined that enforcement of the contract or right would not result in the litigant directly profiting off the possession, cultivation or distribution of marijuana. Consistent with several prior federal court decisions, however, the Nevada District Court in the Bart Street decision has drawn a line where enforcing the contract would mandate violation of federal law. This decision raises questions on where the line is drawn for enforcing a contract in federal court. This has deep implications for every cannabis stakeholder.

Originally published in Insight

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