Brand & Branch llp’s Public Comment
in Opposition to Proposed Regulation 5032(b)
November 5, 2018
Via Email Only
Lori Ajax, Chief
Bureau of Cannabis Control
P.O. Box 419106
Rancho Cordova, CA 95741
Dear Chief Ajax:
This public comment is submitted on behalf of Brand & Branch LLP (“the Firm”), an Oakland-based, women-owned law firm representing Medicinal and Adult-use Cannabis Regulation and Safety Act (“MAUCRSA”) licensees and intellectual property owners who may not hold state-issued licenses to operate a cannabis business in this state (“IP Owners”) in the areas of IP protection, IP licensing, commercial transactions, and regulatory compliance. The firm represents a large number of interests both within California and outside the state representing billions of dollars in revenue, and is a leader in the area of intellectual property protection for cannabis companies and those who wish to work with state-licensed cannabis companies.
We founded our firm in 2015 to provide legal services to cannabis businesses navigating first California’s medical cannabis laws and later a complex set of statutes and regulations that govern both medical and adult use cannabis businesses. Over the past three and a half years, we’ve gotten to know two distinct groups of clients: first, legacy operators who ran cannabis collectives authorized by the Compassionate Use Act and who, in many cases, have been unable to obtain a license under MAUCRSA and have instead matured into IP owners who work with MAUCRSA licensees to leverage the brand goodwill they developed over many years in the nascent California medical market; and second, newer entrants to what is now a highly-regulated medical and adult-use industry, who, rather than seeking a MAUCRSA license, have opted to work with MAUCRSA licensees in order to provide the industry with capital, robust intellectual property often developed outside of the cannabis industry, technological and formulation expertise, and a level of business sophistication that was difficult for companies operating in the gray market to achieve. While these groups are distinct in many ways, they share at least one thing in common: the contribution they provide to the California cannabis industry is based not on their license to engage in commercial cannabis activity but rather the value they bring to the market through their relationships with MAUCRSA licensees.
Like our clients, our value, too, comes not from our ability to engage in commercial cannabis activity but from the expertise we bring to support this burgeoning industry. We are a small business whose expertise primarily lies in supporting transactions such as IP license agreements, white labeling agreements, and other transactions between IP owners and MAUCRSA licensees. Our focus is on ensuring that these transactions happen lawfully and in a manner that complies with California laws and regulations.
Around the time we founded Brand & Branch, we also co-founded the National Cannabis Bar Association (NCBA). We founded NCBA because we saw a need for a new type of attorney—cannabis business attorneys—to come together to support a growing industry and to help businesses navigate complex and constantly shifting regulations. In particular, we sought to connect with attorneys in other states to ensure that any license agreements that involved sharing intellectual property among companies operating in multiple cannabis markets were compliant with the laws of the relevant state or locality in which the activities contemplated by the agreement were to take place. We sought then, as we still do, to elevate the level of sophistication in this industry by providing the type of high-quality legal services that one would expect in any industry—whether technology, consumer products, or cannabis. Our mission, as a firm and as a bar association, is to ensure that the transactions that occur between licensed cannabis operators and the businesses that support them by sharing capital and intellectual property, among other resources, are first and foremost compliant with all relevant laws.
We write today to express our strong opposition to Bureau of Cannabis Control’s (“the Bureau”) proposed regulation Section 5032(b) (“the Proposed Regulation”)  appearing in the draft of the permanent regulations under Title 16 of the California Code of Regulations released on October 19, 2018.  We don’t have any special insight into why the Bureau has sought to promulgate the Proposed Regulation. What we do have is unique insight into the types of relationships contemplated by the Proposed Regulation and the significant harm that our industry—and our firm—would suffer if the Proposed Regulation were adopted.
We have reviewed the 15-Day Notice Of Modification To Text Of Proposed Regulations And Addition Of Documents And Information To The Rulemaking File (“15-Day Notice”) issued by the Bureau in connection with the Proposed Regulation, which states, in relevant part, that the Proposed Regulation was added because “The Bureau has received information that licensees may be engaging in such conduct; therefore, this clarification is necessary to assist licensees with determining what activity is allowed.”
Because the 15-Day Notice does not provide specific details about the basis for the Proposed Regulation’s prohibition on current practices, in this public comment we address what we believe may be the Bureau’s primary concerns—namely, (1) whether non-licensees take title to or otherwise handle cannabis or cannabis products; and (2) whether IP owners or non-licensees in contract with MAUCRSA licensees can require MAUCRSA licensees to violate or otherwise ignore Bureau regulations.
Whatever the Bureau’s concerns, we respectfully submit that the Proposed Regulation is overbroad and any concerns it purports to address can be addressed in a manner that will cause significantly less disruption to the current industry. If the Proposed Regulation is enacted as presently written, it will have a devastating effect on the developing California cannabis market, California’s tax revenues, and businesses of all sizes. Moreover, we believe the Proposed Regulation constitutes a “substantial change” that was not reasonably foreseeable and therefore the public should be granted more than 15 days to comment.
1. The Proposed Regulation Would Undermine Current Business Practices of MAUCRSA Licensees and the IP Owners Who Contract With Them.
We take this opportunity to provide an overview of how our non-MAUCRSA licensee clients currently structure their IP partnerships with MAUCRSA licensees. Our years of experience serving these clients gives us a unique vantage point and an ability to provide the Bureau with much-needed insight into the types of relationships it seeks to prohibit. It is our hope that in sharing this overview, the Bureau will have a better understanding of how these relationships comply with MAUCRSA and are beneficial to both the industry and consumers. That we and our NCBA colleagues are here ensuring that our non-MAUCRSA licensee clients enter into legally sophisticated business arrangements with MAUCRSA licensees should provide precisely the transparency, safety, and accountability that we suspect the Bureau is seeking.
Preliminarily, we note that the practices of “co-packing” and “private labeling” are closely related to “white labeling” and other forms of IP licensing; there are nuances to those terms that are not relevant to this letter, but it bears mentioning such practices would also be impacted, and when we use the term “white labeling” we also mean those practices.
We will use the term “white labeling” to mean a practice whereby a company owning a trademark, copyright, patent, or trade secret (“IP Owner”) enters into a contract with a MAUCRSA licensee that allows the MAUCRSA licensee to use the IP Owner’s trademark, copyright, patent, or trade secrets in connection with certain activities, typically either in exchange for a set per-unit fee paid to the MAUCRSA licensee or a profit-based royalty on the MAUCRSA licensee’s sales paid to the IP Owner. Most often, the MAUCRSA licensee is a manufacturer, and the manufacturer produces, packages, and labels a cannabis product that bears the brand of the IP Owner. White labeling falls within the broader category of IP licensing; licensing by an IP Owner occurs throughout the supply chain. It is common practice in the cannabis industry throughout California, and in other states with regulated cannabis markets. IP licensing is likewise ubiquitous in other industries.
a. Current practices are structured so that IP Owners never take title to cannabis goods and require compliance with MAUCRSA and all relevant regulations.
Notably, all cultivation, manufacturing, and distribution practices engaged in by MAUCRSA licensees in contract with IP Owners strictly comply with MAUCRSA and the relevant regulations governing that licensee’s activities. Under no circumstance may an IP Owner require a MAUCRSA licensee to violate or otherwise ignore Bureau regulations; a contract that requires a party to violate the law would be void for public policy reasons. Indeed, the contracts we and our colleagues draft between IP Owners and MAUCRSA licensees explicitly require such compliance, and termination provisions are typically triggered if a MAUCRSA licensee comes out of compliance.
Likewise, it is important for MAUCRSA compliance that an IP Owner never handles or holds title to cannabis or cannabis products under white labeling practices. If an IP Owner were to hold title, it would need a MAUCRSA license. Accordingly, contracts between IP Owners and MAUCRSA licensees never require the IP Owner (who is not a MAUCRSA licensee) to handle or take title to cannabis or cannabis products. IP Owners who meet the definition of financial interest holder or owner are disclosed appropriately on the MAUCRSA licensee’s application for licensure.
While IP Owners may impose requirements on how their intellectual property may be used by MAUCRSA licensees, it is crucial to note that such requirements do not allow IP Owners to control all of the MAUCRSA licensees’ conduct or operations and do not conflict with—or require the MAUCRSA licensee to violate—state or local law or regulations. The IP Owner’s specifications are there to protect the brand and to protect the public and ensure consumer safety; they are not intended to exert undue control over the licensee. Maintaining public safety and integrity of the supply chain throughout the white labeling process is necessary for both IP Owners and MAUCRSA licensees, and white labeling relationships and agreements adhere to this goal.
2. The Proposed Regulation is Unnecessary.
It is unnecessary to further regulate the relationship between IP Owners and MAUCRSA licensees because (1) MAUCRSA licensees are already required to comply with MAUCRSA and its regulations and (2) the activities of an IP Owner who does not hold a MAUCRSA license are not commercial cannabis activity as defined by MAUCRSA.Holding title to and/or possessing cannabis goods is the hallmark of commercial cannabis activity. MAUCRSA licensees providing white labeling services are engaging in commercial cannabis activity—hence their licensure under MAUCRSA. But IP Owners are not engaging in commercial cannabis activity because licensing intellectual property does not fall within the definition of commercial cannabis activity and because IP Owners do not hold title to cannabis and cannabis goods.
White labeling arrangements are transactions between private parties, and the free market should be able to let them conduct business without undue government interference. Commercial cannabis activity and cannabis goods in California are highly regulated, and the safety and welfare of California’s residents and environment are already sufficiently protected through existing law and regulation. For example, if a consumer gets sick from a cannabis product produced under a white labeling agreement, the manufacturer is listed on the label of the product and can be traced through the state’s track & trace system. Similarly, advertising of cannabis goods requires the licensee’s name and license number to appear on the advertising. IP licensing does not diminish the accountability and traceability that MAUCRSA and the regulations require.
It is incumbent upon MAUCRSA licensees to manage the relationships with their white labeling partners through well-drafted contracts. Likewise, intellectual property law requires IP Owners to control the quality of the products associated with their intellectual property. MAUCRSA compliance, commercial contracts, and intellectual property law act all act in tandem as guideposts for white labeling and other IP licensing, thereby ensuring that these transactions are an effective and safe way to guarantee consumers have safe access to cannabis goods within a regulated but diversified marketplace.
White labeling is a standard practice in nearly every industry involving consumer products, including but not limited to technology, dietary supplements, food, pet products, and cosmetics. For example, the products sold at Trader Joes under the TRADER JOE’S brand are manufactured by third parties under white labeling practices. The more the cannabis industry is regulated like other industries while still maintaining the important product safety controls already in place, the more the industry will be able to thrive and generate tax revenue for the state.
3. The Proposed Regulation Will Cause Substantial Harm to Consumers and Patients, Cannabis Businesses, and the State of California.
As discussed at length above, white labeling and IP licensing are ubiquitous in the current California cannabis market as well as in other states with regulated cannabis markets. As a result, the Proposed Regulation, if enacted, will create a significant setback to an industry that is just beginning to get its bearings. Requiring IP Owners and MAUCRSA licensees to terminate their existing contracts will cause substantial disruptions in the supply chain, leading to a host of unintended consequences. Among other things, this is likely to trigger an increase in illicit market activity, as consumers will not be able to access products when supply in the legal market runs low.
Similarly, preventing IP Owners from licensing IP to MAUCRSA licensees will create barriers to badly-needed access to investment funds and other resources that will allow MAUCRSA licensees to develop professional operations and expend the capital needed to remain in compliance with MAUCRSA. Without adequate funding, MAUCRSA licensees will be unable to operate, depriving the state of tax revenue from their operations.
Ultimately, consumers and patients will also be unduly harmed by the restrictions imposed by the Proposed Regulation. There is a great deal of innovation currently underway in the area of manufactured cannabis products. These products are quite complex, requiring highly-sophisticated technologies and ongoing research and development. Such expertise is the domain of, for example, formulations scientists—not necessarily MAUCRSA licensees. MAUCRSA licensees should not be forced to expend the capital and other resources necessary to bring all of this expertise in-house when they could simply work with existing experts to refine the process of manufacturing these products instead of reinventing the wheel.
4. The Proposed Regulation Is Unlawful and Should Not Be Adopted.
a. The Proposed Regulation Violates Bus. & Prof. Code Sections 26013 and 26014.
Bus. & Prof. Code Section 26013 requires licensing authorities to adopt reasonable rules and regulations for the implementation of MAUCRSA. The regulations must be necessary to achieve the purposes of MAUCRSA and based on available evidence. Contrary to this mandate, given its breadth and vagueness, the Proposed Regulation is neither reasonable, necessary, nor based on any available evidence.
Further, as noted above, the Proposed Regulation is likely to cause substantial disruptions in the legal cannabis supply chain, perpetuating the illicit market for cannabis. Bus. & Prof. Code Section 26014 specifically requires the Bureau to “convene an advisory committee to advise the licensing authorities on the development of standards and regulations pursuant to this division, including best practices and guidelines that protect public health and safety while ensuring a regulated environment for commercial cannabis activity that does not impose such barriers so as to perpetuate, rather than reduce and eliminate, the illicit market for cannabis” (emphasis added). The Proposed Regulation is decidedly counter to this mission.
b. The Proposed Regulation Is A Violation of the Interstate Commerce Clause and the Dormant Commerce Clause.
In many instances, IP Owners lawfully enter into agreements to license their intellectual property across state lines to expand into cannabis markets in other states—including license agreements with MAUCRSA licensees. The Proposed Regulation, if enacted by the Bureau, would prevent IP Owners outside of California from participating in the California cannabis market via white labeling agreements in violation of the dormant commerce clause.
c. The Proposed Regulation is a Violation of Administrative Law.
The Proposed Regulation violates administrative law for a variety of reasons, two of which we discuss here. First, administrative law requires the agency to consider "competitive advantages or disadvantages for businesses currently doing business in the state" in its promulgation of any new “major” regulations. See Gov. Code, § 11346.3. Many IP Owners, including some of the largest in the cannabis industry, are based in California, and as a result of the Proposed Regulation they will likely experience a financial loss that will have a major impact on the state’s economy. The Proposed Regulation will greatly reduce the revenue derived from white-labeled cannabis goods and drive enterprise and consumers into the illicit market, increasing the costs of enforcement and thereby altering the economic impact assessment previously put forth by the Bureau. In addition, preventing out-of-state IP Owners from licensing their IP to MAUCRSA licensees in California is likely to cause other states to retaliate with similar regulations, thereby preventing California IP Owners from licensing their IP to cannabis businesses in other states.
Second, a regulatory change must be “sufficiently related to the original text that the public was adequately placed on notice that the change could result from the originally proposed regulatory action.” Gov. C. § 11346.8(c). Again, this standard was not met. The industry has been blindsided by the Proposed Regulation. There was no indication in any material previously published by the Bureau that it was going to make changes as broad and sweeping as the Proposed Regulation. Proposition 64, which was cited as the basis for the implementation of MAUCRSA in its recitals, makes no mention of, much less prohibits, the practice of white labeling. The Proposed Regulation was noticed pursuant to a 15-day comment period, which is not nearly enough time to respond to such a substantial change. At a minimum, the Proposed Regulation should have been noticed under a 45-day comment period. It is not only MAUCRSA licensees that must strictly comply with the law—the Bureau must also strictly adhere to these standards of administrative law.
These concerns regarding the administrative process by which the Bureau has promulgated the Proposed Regulations are not trivial. The many practical implications of the Proposed Regulation addressed in our comment appear to have been neither intended nor considered by the Bureau. And, while we lack the data and ability to calculate the Proposed Regulation’s impact with precision, it appears clear that the economic impacts of the regulation could easily eclipse the $50 million threshold necessary to qualify the regulation as a “major” regulation under the Administrative Procedure Act. Not only does this render the Proposed Regulation subject to future challenge, but, perhaps more critically, it also throws into stark relief the policy reasons for appropriately considering these impacts before requiring the industry to contend with them.
5. The Bureau’s Aims Can Be Accomplished Without Adopting the Proposed Regulation.
Given all of the above, the Firm strongly urges the Bureau to delete the Proposed Regulation in its entirety. In the absence of complete deletion, we recommend the Bureau consider the following alternatives in the order in which they appear. We regret that we are unable to be more helpful in proposing these solutions, but without knowing the Bureau’s reasons for proposing the Proposed Regulation in the first place we are limited to guessing what its goals may be.
a. Rewrite the Proposed Regulation to allow for white labeling.
The following is a possible change to the Proposed Regulation that removes the vague and overbroad language. This change brings the regulation squarely in line with other existing regulations prohibiting anyone without a MAUCRSA license from touching or holding title to cannabis or cannabis goods.
§ 5032. Commercial Cannabis Activity
(b) Licensees shall not conduct commercial cannabis activities
on behalf of, at the request of, or pursuant to a contract with any person that is not licensed under the Act. Such prohibited commercial cannabis activities include, but are not limited to, the following: (1) Pprocuring or purchasing cannabis goods from a non-licensed cultivator or non-licensed manufacturer. Licensing of intellectual property shall not be construed as commercial cannabis activity under the Act. (2) Manufacturing cannabis goods according to the specifications of a non-licensee. (3) Packaging and labeling cannabis goods under a non-licensee’s brand or according to the specifications of a non-licensee. (4) Distributing cannabis goods for a non-licensee.
b. Require a written contract for white labeling or IP licensing without requiring disclosure of such contract.
The Bureau could rewrite the Proposed Regulation to require that the IP Owner have a written contract with the MAUCRSA licensee. A written contract requiring the licensee’s full compliance with MAUCRSA will be more likely to be enforceable in a court of law where it will be subject to long-standing and well-established principles of contract law and IP licensing. A written contract also helps the parties legitimize their business dealings.
Commercial Cannabis Activity Commercial Cannabis Activity on Behalf of a Non-Licensee
(b) Licensees shall enter into a written agreement with a non-licensee when the licensee engages in commercial cannabis activity on behalf of a non-licensee. In any such agreement, title and possession to cannabis and cannabis product shall remain with the licensee. The written agreement shall require full compliance with the Act and regulations thereunder.
not conduct commercial cannabis activities on behalf of, at the request of, or pursuant to a contract with any person that is not licensed under the Act. Such prohibited commercial cannabis activities include, but are not limited to, the following: (1) Procuring or purchasing cannabis goods from a licensed cultivator or licensed manufacturer. (2) Manufacturing cannabis goods according to the specifications of a non-licensee. (3) Packaging and labeling cannabis goods under a non-licensee’s brand or according to the specifications of a non-licensee. (4) Distributing cannabis goods for a non-licensee.
c. Create a licensing category for IP Owners but don’t require local approval.
Finally, the Firm recommends creating a separate MAUCRSA license category for IP Owners who do not otherwise hold a license under MAUCRSA. Much like the issuance of an event organizer license, the IP Owner license should not require local approval. Local approval is irrelevant to intellectual property, which is intangible.
6. The Bureau Should Not Adopt the Proposed Regulation.
Implementation of the Proposed Regulation would stop the industry in its tracks. White labeling is important for the growth of the industry—not just in California, but nationwide and internationally as well. White labeling allows indirect but lawful and transparent participation in the industry by smaller companies who would otherwise be unable to secure a MAUCRSA license due to lack of resources and capital. This includes IP Owners who were lawfully operating under the Compassionate Use Act but who are unable to relocate to local jurisdictions that allow commercial cannabis activity. White labeling encourages diversity of products, promotes the development of a free market economy devoid of unreasonable and burdensome government oversight, helps protect consumers and patients, and encourages consumer choice. The prohibition on white labeling and IP licensing by non-MAUCRSA licensees would stifle technological development and prohibit licensing of patents and proprietary methods.
Moreover, the Proposed Regulation would deprive the State of California of the tax revenue it needs to ensure success of the legal cannabis market. Without white labeling, smaller manufacturers would not be able to partner with IP Owners and produce more taxable goods for the marketplace.
Thank you for taking the time to read this public comment. Our firm is passionately dedicated to supporting the development of a safe and legal industry where businesses can work together to better serve California patients and consumers. We look forward to working with the Bureau on this issue and ensuring the success of the cannabis industry in California.
Shabnam Malek and Amanda R. Conley
Brand & Branch LLP
The wording of the Proposed Regulation is as follows:
§ 5032. Commercial Cannabis Activity
(b) Licensees shall not conduct commercial cannabis activities on behalf of, at the request of, or pursuant to a contract with any person that is not licensed under the Act. Such prohibited commercial cannabis activities include, but are not limited to, the following:
(1) Procuring or purchasing cannabis goods from a licensed cultivator or licensed manufacturer.
(2) Manufacturing cannabis goods according to the specifications of a non-licensee.
(3) Packaging and labeling cannabis goods under a non-licensee’s brand or according to the specifications of a non-licensee.
(4) Distributing cannabis goods for a non-licensee.
Although the Firm has feedback on other proposed regulations, this public comment is singularly focused on the Proposed Regulation.
Bus. & Prof. Code Section 26001(k) reads: ““Commercial cannabis activity” includes the cultivation, possession, manufacture, distribution, processing, storing, laboratory testing, packaging, labeling, transportation, delivery or sale of cannabis and cannabis products as provided for in this division.”
See, e.g., Ole Rogeberg, Prohibition, Regulation or Laissez Faire: The Policy Trade-Offs of Cannabis Policy, 56 Intl. J. Drug Policy 153 (2018).
Unfortunately, the Firm is not able to provide specific numbers on the potential impact at the time of submitting this comment. Please contact us if you’d like us to provide further data.