The ominous tagline for the movie “Jaws 2” famously warned:  “Just when you thought it was safe to go back in the water.”  Although unlikely to receive even the mixed reviews that that 1978 film received, the U.S. District Court for the Western District of Washington’s recent ruling in Polk v. Gontmakher, No. 2:18-cv-01434-RAJ, 2019 WL 4058970 (W.D. Wash. Aug 28, 2019), is likely to send shivers down the spine of the U.S. cannabis industry.  Bucking an apparent trend of courts enforcing cannabis-related contracts, this federal district court concluded that federal law prohibited the enforcement of an agreement between partners in a cannabis growing operation.  Citing the U.S. Controlled Substances Act (the CSA), the court found that “awarding [the plaintiff] an ownership interest in, or profits from, [the cannabis-related business] contravenes federal law.”  Thus, just when the cannabis industry thought it was safe, and that federal courts would continue to enforce cannabis-related agreements, this decision ominously surfaced.

Overview

The facts of Polk are relatively straight-forward:  After Washington state passed an initiative “regulating the production, distribution, and sale of marijuana and removing related state criminal and civil penalties[,]” the plaintiff and the defendant “orally agree[d] to be ‘equal partners’ in their cannabis growing venture.”  Thereafter, they agreed to modify their respective percentages of ownership such that the plaintiff maintained a 30-percent ownership stake in the cannabis-related business – an “‘interest’ [that] would be held in the name of one of [the defendant’s] relatives” because the plaintiff was not eligible to hold a state cannabis license.

“Over time, [the plaintiff] explored different ways to make his ownership interest in [the business] legal.  Although these efforts were unsuccessful, he stayed with [the business] at [the defendant’s] encouragement.  Finally, in September 2015, [the plaintiff] left [the business].  After his departure, [the defendant] disputed what he owed [the plaintiff] for his alleged interest in [the company].  As a result, in 2018, [the plaintiff] sued [the defendant and others], alleging, among other things, that he is entitled to an ownership interest in [the business] and past and future profits” (internal citations omitted).  The defendant moved to dismiss a number of the claims asserted by the plaintiff.

The decision

The district court granted the defendant’s motion.  Before turning to whether the agreement was enforceable under Washington state law, the court found that the agreement was not enforceable under federal law.  It explained that “where it is alleged that an agreement violates a federal statute, courts look to federal law.”  It further explained:  “Contracts that violate a federal statute are illegal and unenforceable.”  Thus, after observing that, under the CSA, “the production, distribution, and sale of marijuana remains illegal[,]” the court stated that “any agreement giving [the plaintiff] an equity interest [in the cannabis-related business] is illegal under federal law.”

Thereafter, the court expressly rejected the plaintiff’s arguments that the agreement was nevertheless enforceable.  The plaintiff, the court stated, “argues that the CSA is not an absolute bar to enforcement where the requested remedy does not require a violation of the CSA.  The Court agrees.  However, [the plaintiff’s] characterization that he is only requesting monetary damages is inconsistent with his Complaint.  [The plaintiff] is not requesting monetary damages that can be obtained legally.  He is asserting an equity interest in [the cannabis-related business] and a right to past and future profits.  [The business] is a company that produces/processes marijuana” (internal citations omitted).  “Thus,” although cannabis was legal under state law, the court concluded, “awarding [the plaintiff] an ownership interest in, or profits from, [the business] contravenes federal law.”

Bucking the trend

For some time, it has appeared that federal courts have been more and more willing to enforce cannabis-related contracts in states where cannabis is legal.

For example, in The Green Earth Wellness Center, LLC v. Atain Specialty Insurance Company, 163 F. Supp.3d 821 (D. Colo. 2016), the U.S. District Court for the District of Colorado found that an insurance policy was enforceable.  Citing “a continued erosion of any clear and consistent federal public policy in th[e cannabis] area,” that court “decline[d the insurer’s] indirect invitation to declare the [insurance p]olicy void on public policy grounds.”  It concluded that the insurer, “having entered into the [p]olicy of its own will, knowingly and intentionally, is obligated to comply with its terms or pay damages for having breached it.”  

More recently, another U.S. district court permitted the plaintiff in a different case to try to recoup the benefit of its cannabis-related bargain.  At issue in Value Linx Services, LLC v. Linx Card, Inc., No. 3:18-cv-02126-HZ, 2019 WL 3502895 (D. Or. Aug. 1, 2019), is a dispute between two parties relating to a business arrangement involving the sale of “gift cards bought at kiosks within cannabis dispensaries to allow consumers to purchase cannabis products without cash.”  Just last month, the U.S. District Court for the District of Oregon refused to dismiss the plaintiff’s breach-of-contract, promissory estoppel, and quantum meruit claims in that case.  It did not conclude that such claims must fail because the business arrangement was in any way against the CSA or any other federal law.  To the contrary, considering a theory of liability based on the delegation of contractual duties, that court suggested that the “plaintiff’s allegations [may well be] sufficient to state a claim” for breach of contract.

Polk, however, marks a notable break with what appeared to be a recent trend.  Whether it is simply an outlier or a harbinger of decisions to come remains to be seen, but it seems more likely that the decision ultimately will prove to be an anomaly.

Important differences

Arguably, Polk can be distinguished from cases such as Green Earth Wellness on at least two bases.  First, the district court in Polk rejected the plaintiff’s argument that he was only seeking monetary damages.  Had the plaintiff only been seeking monetary damages, it appears that the court might have been more willing to enforce the arrangement.

Second, the agreement at issue in Polk, the court concluded, was “also illegal under Washington law.”  The plaintiff “was prohibited from obtaining a producer or processor license” in Washington because he had “pled guilty to possession of marijuana with intent to dispense in Virginia (a felony), and possession of drugs in Nevada (a misdemeanor).”  Thus, considering whether the agreement was enforceable under state law, the court determined “that the public good is not served by enforcing this agreement.”  It also determined that “[e]nforcing [the] agreement undermines [the] purpose [of Washington law] by allowing him to profit from an illegal agreement intentionally forged outside the bounds of the state regulatory system.”

The court continued:

“The Court sympathizes with [the plaintiff’s] plight.  He helped build a successful business from the ground up and is now being deprived of the fruits of his labors.  But this is a crisis of his own making.  [The plaintiff’s] interest in [the cannabis-related business] was illegal from the very beginning and he knew it.  As he notes, there was a legal path to obtain the licenses, he just chose not to pursue it.  The Court will not enforce an illegal contract” (internal citations omitted).

While the court did not raise these same specific concerns about the propriety of the plaintiff’s conduct and the agreement when considering whether the agreement was enforceable under federal law, it is hard to imagine that those same concerns played no role whatsoever in the court’s conclusion about the enforceability of the agreement under federal law.

U.S. policy and law in this area, and in all areas involving cannabis, are constantly evolving.  As such, it is important to consult with counsel prior to taking any cannabis-related action.