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IP possibilities, pitfalls in a cannabis business

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Whether you own a restaurant, car dealership, widget factory or any other business, soon after you begin to enjoy commercial success you will likely search for opportunities to increase the scope of your operations. By making your goods or services available in new territories, you can increase market share, create new sources of revenue and strengthen customer loyalty for your brand.

Because time, money and human capital are finite resources, when evaluating how to expand your operations you should consider selling to others the rights to use your business name and other intangible assets instead of commencing operations in each new market by yourself.  While there would be concerns for licensing intellectual property (IP) assets for any business, there are several unique considerations to be evaluated if your company is part of the cannabis industry.

There is currently a conflict between federal and state law with respect to the manufacture and sale of cannabis and cannabis-infused products.  Under the Controlled Substances Act, it remains illegal under federal law to manufacture, sell, process or transport such goods across state borders.  Penalties for violating the CSA include substantial civil fines and imprisonment.

Although in recent years many states have enacted laws that permit the cultivation, processing, sale and/or use of cannabis-related products, such authorization is expressly limited to activities within the state’s borders.  Under the 2013 memorandum commonly known as the Cole Memorandum, the U.S. Department of Justice directed federal prosecutors and law enforcement officials to limit their enforcement of the CSA against businesses operating in accordance with state laws to cases in which there has been a violation of one of eight enforcement priorities.

Cole Memorandum

One such enforcement priority is to “prevent the diversion of marijuana from states where it is legal under state law in some form to other states.” In order to avoid violating the CSA, state laws and the Cole Memorandum, it is essential that business owners do not create any licensing program that calls for transporting controlled substances across state lines.

Although there are strict limitations on transporting infused products between states, businesses may lawfully license their intellectual property to companies in other states. Legal cannabis operators allocate a tremendous amount of time, money and effort to creating and improving their product brands, formulas, cultivation techniques, extraction methodologies, operational methods and supporting documentation. These IP assets do not constitute controlled substances under the CSA, they have tremendous value and they can be both protected and monetized.

The ability for cannabis operators to license their IP assets is also limited because the U.S. Patent and Trademark Office has refused to register marks used for cannabis products, paraphernalia and/or certain related support services.  The USPTO, through its Trademark Trial and Board has consistently held that, to be registered by the USPTO, the use of a mark must be “lawful” under federal law to qualify for federal registration.  Notwithstanding this limitation, operators have been able to register marks with the USPTO in connection with consulting services, educational services and non-infused products.  Operators have also registered their marks with various state registries.

Under the current circumstances, how can operators in one state properly license their IP assets to businesses or applicants in other states?  While licensing deals are not to be viewed as a formulaic or “one size fits all proposition,” such arrangements often include most or all of the following components:

  • A successful operator in the legal cannabis industry creates a separate IP licensing company
  • No controlled substances cross state lines
  • The licensee in each state remains solely responsible for all manufacturing and distribution issues within that state
  • The licensor may provide training, equipment, non-infused supplies and/or operational consulting
  • The parties structure payment terms to comply with the laws of both jurisdictions

Use caution

The parties to the license agreement must also be careful to not create an arrangement which qualifies as an unregistered franchise system. While franchise laws vary from state to state, the Federal Trade Commission’s general definition of a franchise is a system in which: (1) the licensee obtains the right to operate a business that is identified or associated with the licensor’s mark; (2) the licensee exerts or has authority to exert a significant degree of control over the licensee’s operations; and (3) the license makes required payments as a condition to using the license.  In order to avoid this potential problem, a licensor can impose conditions on the use of its mark without attempting to exert any meaningful control on the overall operations of the licensee’s business.

A licensing agreement must also be flexible enough to address what will happen if and when there is a change in the applicable laws, regulations or enforcement policies of either the federal government or any applicable state or local government. Each licensing agreement must be tailored to the specific parties, states, laws, products, services and assets in question.

In particular, license agreements should include payment provisions that do not violate the state laws of either the licensor or the licensee.  In some states, an out-of-state licensor receiving royalties from an in-state licensee would be treated as possessing a direct financial interest in the licensee, which would trigger an in-state residency requirement for the licensor.

Some states with legal cannabis programs restrict the amount and type of payments that may be paid to out-of-state companies.  Additionally, some states prohibit involvement in their cannabis industry by companies that are not licensed to trade in cannabis in the state.

Parties to a cannabis industry license should regularly revisit the contract during the term of the agreement.  Both the licensor and the licensee should regularly make sure that each side is honoring its obligations and identify any changes required due to changes in the law or applicable circumstances.  With proper operating procedures, the parties can make needed amendments to the agreement before a small issue becomes a substantial problem.

Jonathan Wachs is a co-founder of Offit Kurman’s cannabis law group and is the chair of the firm’s intellectual property group. He can be reached at jwachs@offitkurman.com or at 301-575-0302.

 

 

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