It’s been more than three years since California voters legalized the use of recreational marijuana with Proposition 64.
Marijuana is now a multibillion-dollar industry in our state… but there remain many unanswered questions about how the law will handle this budding new industry. As a result, entrepreneurs in the marijuana business find themselves operating under a great deal of uncertainty.
This is why, if you are involved with cannabis at any stage of the supply chain, from cultivating marijuana to selling it at a dispensary, you should start thinking about asset protection.
What Is Asset Protection?
It’s exactly what it sounds like: a set of strategies by which an individual or business can keep their assets from being taken by creditors.
All of us are at some risk of losing our assets to a creditor, and so asset protection should be a consideration for everyone, but some groups are at much higher risk than others. For instance, you’ve probably heard about how certain types of doctors face a very high risk of being sued for malpractice.
Well, if you’re in the marijuana business, you are also in a high-risk profession. And while the risks for you are somewhat different than they would be for a doctor, they should not be underestimated.
Why Asset Protection is Necessary in the Cannabis Industry
You face the same risks as any other business.
Asset protection is important for business owners period, particularly in our litigious state of California. This applies whether you’re selling marijuana or rocking chairs.
There are a variety of things that a business owner can be sued for:
- If someone is injured in your business, you can be sued for premises liability. “Slip and fall” accidents are the most common catalysts for these lawsuits, but there are a number of others, too.
- If an employee or even a customer feels that they were discriminated against based on race, sex, ability, or any other protected factor, then you may be sued for discrimination or sexual harassment. These lawsuits can tar your business with a very bad brush.
- If one of your employees hurts someone, then you may be sued for negligent hiring.
- If a delivery driver for your business gets in an auto accident while on the job, then you may be held liable.
Again, these are the risks you face just by being in business at all. But by being in the marijuana business, you face a whole new level of risk altogether…
You may be sued for product liability.
All businesses which manufacture, design, or distribute products can potentially be sued for product liability. However, as a marijuana businessperson, you are in even greater danger.
Why is this? Well, the health effects of marijuana are not entirely clear, but there is a body of scientific research showing that cannabis use does indeed have certain risks. The CDC has compiled research on a number of effects that marijuana has on the body; these include the potential for addiction and an increased risk of certain types of cancer, as well as possible damage to the heart, lungs, and brain.
Only recently, in fact, a study was published linking marijuana with testicular cancer. While further research is needed before anything can be said definitively, this is a sign of how quickly the scientific views of marijuana can evolve.
Now, this doesn’t negate the benefits of cannabis. And the potential harms associated with it are no worse than (and in many cases not nearly as bad as) those associated with legal substances such as alcohol and tobacco, many types of prescription drugs, and even junk food.
The problem is, sellers of these other risky products have a few legal advantages over the cannabis industry. First of all, the risks of these products are generally common knowledge. If someone tried to sue junk food companies for making them fat, their lawsuit would almost certainly be dismissed on the grounds that they knew what they were getting into when they bought the junk food. Second, products such as tobacco are required to inform consumers of their risks via measures such as warning labels.
It’s an entirely different picture with marijuana. The risks are not as well-established in the public consciousness, and so it will be easier for plaintiffs to portray cannabis businesses as having “deceived” them about their risk level.
In fact, it’s very possible, although by no means certain, that in a few years, the legal marijuana industry may end up being ravaged by these lawsuits, the same way that other industries have been in the past. (Just look at how much the NFL has had to pay recently over concussions, for instance.)
And that’s only talking about the cannabis itself. It isn’t even touching on liability issues regarding cannabis-related products that may be sold at dispensaries or smoke shops, such as e-cigarettes, which can be catastrophically dangerous.
Remember, if you are sued for product liability, there is a very good chance that it will end up becoming a class action lawsuit, with hundreds or even thousands of people suing you at once. If you want to take steps to protect against just such a business nightmare, then you need to start thinking about asset protection.
But that isn’t all…
You might face entirely new legal risks, such as the extension of “dram shop laws” to the cannabis industry.
In addition to current laws, you should be prepared for the possibility of future laws being passed that will open you up to entirely new avenues of legal liability.
One thing to watch for on this front is the passage of marijuana dram shop laws.
In many states, if a bartender serves alcohol to a patron who then injures someone through their intoxication, typically by driving drunk, then the bartender can be held legally responsible for the injury. This is meant to frighten bartenders out of serving alcohol to already intoxicated people, but in reality, such laws subject even responsible bartenders to significant liability.
Imagine if you were sued because you sold marijuana to someone who then drove while high and caused a serious car crash. How much would someone else’s bad decision cost you?
The dram shop laws in California are more lenient than those in most other states. However, this is no guarantee that dram shop liability will not be applied to marijuana dispensary owners, either through legal statute or case law. This depends largely on the caprices of the legal system and public opinion.
This is just one example of the sort of worrisome eventuality that you will have to be prepared for when doing business in the marijuana industry.
You face strict regulations from the state.
It’s not just private plaintiffs that should be on your radar, either. As you undoubtedly know if you’re part of the industry, “legal” cannabis is a heavily regulated industry, and these regulations can be complex and confusing.
The matter of regulation is indeed far too complex for us to discuss in depth here, but you can read more about cannabis regulation on the state government’s website.
If you run afoul of these regulations, you may be serious trouble. Indeed, in the short time that marijuana has been legal in California, the state has already gone after dispensaries for millions in damages when regulations have been violated.
The best thing to do with these regulations, of course, is attempt to follow them as thoroughly as possible. But even the most diligent business owner can make mistakes…
You are operating in an industry with weak legal precedent.
The modern state of California was founded by pioneers who came during the 1849 Gold Rush. These pioneers found open land on which to stake their claims, and some of them ended up becoming very rich as a result.
If you are part of California’s modern-day Green Rush, you are also a pioneer staking your claim in uncharted territory. As with the original gold seekers, you may be rewarded handsomely for your entrepreneurial spirit, but you may also expose yourself to a set of unforeseen legal risks.
Remember, the law in California (and in most of the United States) is based on case law as well as the written legal statute. When a judge makes a decision in a case, then this decision sets a precedent, and judges handling similar cases in the future will have to take this precedent into account. Over time, a particular legal field will develop a broad body of case law, and many of the legal ambiguities will be resolved.
There’s none of this for the marijuana industry. Since legal marijuana is so new, and since there was absolutely no case law regarding the illegal drug deals that occurred beforehand, you are operating in an area with very little legal precedent.
If your case has no precedent, you can’t have your attorney look at past cases to come up with a reasonable prediction of how things might go. Instead, your case could potentially go several ways, depending on the whims of the judge and the skill with which your attorneys and your opponents’ attorneys present their arguments.
In fact, your case might end up being the one to set the precedent… but while this may earn you a place in the legal textbooks, it’s usually not a good place to be in when it comes to your pocketbook.
How to Protect Your Assets
So, those are the risks. What can you do about them?
There are a number of asset protection steps you can take. However, some of the most effective revolve around where you place your money…
Corporations versus LLCs
Both corporations and LLCs (Limited Liability Companies) offer the fundamental asset protection benefit of limited liability.
This means that if your business is sued, you are not personally liable for the business debt. The creditor may be able to collect all of the assets within the business itself, but your liability will be limited to this. They cannot take your house or car or other personal property, so long as you did not mingle these assets with the business.
The main alternative to incorporating is to operate as a sole proprietorship, which means that you have no limited liability protection and your personal assets will be vulnerable to business lawsuits.
Therefore, one of the simplest and most effective steps you can take to protect your assets is to file the paperwork for a corporation or LLC.
Which of the two should you create? It depends on a variety of factors, but generally LLCs are preferable for asset protection because they protect your assets the other way as well: business assets are protected against personal liability.
If you are personally sued and you own a corporation, then the creditor can simply take your corporate stock. Ownership of an LLC is more flexible, however, so the creditor must go through the difficult process of obtaining a charging order if they want to collect assets.
Offshoring Your Assets
If you want to protect your assets to the greatest degree possible, then the logical step is to place them in an asset protection trust and take them offshore.
Here’s how it works in a nutshell: a trust is a legal construct by which one party holds assets on behalf of another. Trusts have multiple uses, including estate planning, but a certain type of trust known as a self-settled trust can be used to protect assets from creditors.
There are a few jurisdictions in which you can set up asset protection trusts, but the safest of these by far is the Cook Islands, a small nation in the South Pacific near New Zealand. The Cook Islands has passed laws making it extremely difficult for a foreign creditor to obtain assets placed there.
Setting up a foreign asset protection trust is perfectly legal, so long as you fill out the proper IRS forms and pay all your taxes, and it is perhaps the strongest way possible to protect your assets.
If you have an LLC, you may have the option of offshoring this as well. When it comes to offshoring an LLC specifically, the best jurisdiction for this is the island of Nevis in the Caribbean. Much like the Cook Islands, Nevis has passed laws specifically designed to make it a haven for foreign asset protection.
Offshore asset protection can be expensive. Creating a domestic asset protection trust in a debtor-friendly state such as Nevada can be less expensive, but it also affords you less protection. If you are in a dangerous industry such as cannabis, then it is up to you to decide what level of risk you believe to be appropriate, but we would generally recommend erring on the side of caution.
For more information, check out our article comparing foreign and domestic asset protection trusts.
Fraudulent Transfer: The Importance of Acting Early
When should you start planning how to protect your assets?
The answer is, as soon as possible. An asset protection plan must be made far in advance of an actual debt arising in order to be maximally effective.
This is necessary to protect yourself against something known as fraudulent transfer. If you transfer your assets out of your possession so as to avoid a specific debt, then that transfer may be nullified.
And since the cannabis industry is so volatile, the best time to start thinking about asset protection is right now.
At Bohm Wildish & Matsen, we have decades of combined experience helping clients in all sorts of businesses protect their assets. We are excited to help protect the cannabis industry as it grows in this state, because we recognize that cannabis professionals deserve the same respect as anyone else who takes the courageous step of starting a business.
If you work at any point on the cannabis supply chain and would like to learn more about your options, give us a call today.