Business
Cannabis Litigation: What is “Alter Ego” liability?
When going into business—whether cannabis or otherwise— the first step is to create a business entity. (This seems obvious but still eludes many in the cannabis industry.) One of the principal purposes of establishing a business entity to limit the personal liability exposure of the founders. Typically, the business entity itself and not the investors, owners, or managers of the entity, is liable for the debts of the business in nearly all circumstances. One exception is the alter ego theory of liability.
The alter ego theory of liability attempts to reach pockets beyond the putatively liable business entity. Doing so is known at piercing the corporate veil. The alter ego theory of liability is not limited just to piercing a company to reach into the pockets of the owners. It may also be used to reach into other entities. And veil piercing may be accomplished in few different ways.
- Vertical piercing refers to piercing the veil between a subsidiary and its parent to hold the parent company liable.
- Horizontal piercing refers to using the alter ego theory of liability to hold sister company’s liable.
- Reverse piercing refers to using the alter ego theory of liability to hold a company liable for the conduct of its owners.
A recently filed Oregon cannabis case demonstrates uses of the alter ego theory in its traditional and horizontal forms. The plaintiff is a well-known purveyor of cannabis candies, licensed by the OLCC. The plaintiff markets its candies to licensed marijuana dispensaries throughout Oregon. The dispensaries sell the candies to their customers. Since 2019, plaintiff has done business with a set of dispensaries that operate under the same brand and have the same or substantially the same owners. (In other words, this brand operates numerous dispensaries throughout Oregon which have the same owners.) Each dispensary operates is its own entity. But each is under the common control of the same two individuals.
According to the complaint, defendants failed to pay for approximately $390,000 of cannabis candies. The candies allegedly were delivered by plaintiff to the various defendants, who accepted the candies without complaint and sold them to retail customers. After demanding and not receiving payment, plaintiff filed suit against more than 20 companies and their two principals. In the absence of an alter ego theory of liability, each defendant is liable only for the candies for which it did not pay. So the plaintiff’s recovery for each dispensary is limited.
But the plaintiff pleaded a traditional and horizontal claim for alter ego liability. In other words, plaintiff seeks to hold each defendant—all of the dispensaries and the two owners—liable for the candies purchased by the other. A claim for alter ego liability is not typically available to an aggrieved party. A claim for alter ego liability is also not available just because the same individuals own multiple companies. Similarly, a claim for alter ego liability is not available just because all of the companies all operate under the same brand or operate in the same industry.
So in what circumstances can a plaintiff allege a claim for alter ego liability?
Well, the specifics differ from state to state. But generally, for the horizontal alter ego theory, a plaintiff needs to allege that the defendants had common supervision, control, management and unity of interest. For all theories, a plaintiff usually must allege the defendants failed to follow corporate formalities. That’s a way of saying that the owners/companies did not act as though the companies were separate entities or separate from themselves. This conduct may include failing to hold board meetings, comingling business and personal monies, or comingling between companies earnings, expenses, and losses. It may also include owners treating company accounts as mere “piggy banks” rather than properly issuing dividends or distributions. Other factors may include insufficient capitalization, insolvency at the time of the transaction in question, siphoning funds by one or more owners, the absence of corporate records, or non-functioning officers or directors.
As the name suggests, the “alter ego” theory of liability ultimately concerns whether the members or shareholders have treated the corporate entity as a “mere instrumentality” or “alter ego” of themselves. Typically the bar to pierce the veil is high, and a court’s use of its equitable powers is exercised only when there is clear evidence that those in control of a company have used the corporation for improper means such as fraud.
Keep in mind that a plaintiff must have a reasonable good faith belief that its allegations are true. Oftentimes a plaintiff does not have enough information to allege a claim for alter ego theory liability. But where a plaintiff does have such information, a claim for alter ego liability is a powerful one. It allows the plaintiff to reach past the ordinary limitations of liability into the pockets of shareholders, members, or sister or parent companies.
Source: https://harrisbricken.com/cannalawblog/cannabis-litigation-what-is-alter-ego-liability/
New Mexico regulators fined a cannabis operator nearly $300,000 and revoked its license after the company allegedly created fake reports in the state’s traceability software.
The New Mexico Cannabis Control Division (CCD) accused marijuana manufacturer and retailer Golden Roots of 11 violations, according to Albuquerque Business First.
Golden Roots operates the The Cannabis Revolution Dispensary.
The majority of the violations are related to the Albuquerque company’s improper use of BioTrack, which has been New Mexico’s track-and-trace vendor since 2015.
The CCD alleges Golden Roots reported marijuana production only two months after it had received its vertically integrated license, according to Albuquerque Business First.
Because cannabis takes longer than two months to be cultivated, the CCD was suspicious of the report.
After inspecting the company’s premises, the CCD alleged Golden Roots reported cultivation, transportation and sales in BioTrack but wasn’t able to provide officers who inspected the site evidence that the operator was cultivating cannabis.
In April, the CCD revoked Golden Roots’ license and issued a $10,000 fine, according to the news outlet.
The company requested a hearing, which the regulator scheduled for Sept. 1.
At the hearing, the CCD testified that the company’s dried-cannabis weights in BioTrack were suspicious because they didn’t seem to accurately reflect how much weight marijuana loses as it dries.
Company employees also poorly accounted for why they were making adjustments in the system of up to 24 pounds of cannabis, making comments such as “bad” or “mistake” in the software, Albuquerque Business First reported.
Golden Roots was fined $298,972.05 – the amount regulators allege the company made selling products that weren’t properly accounted for in BioTrack.
The CCD has been cracking down on cannabis operators accused of selling products procured from out-of-state or not grown legally:
- Regulators alleged in August that Albuquerque dispensary Sawmill Sweet Leaf sold out-of-state products and didn’t have a license for extraction.
- Paradise Exotics Distro lost its license in July after regulators alleged the company sold products made in California.
Golden Roots was the first alleged rulebreaker in New Mexico to be asked to pay a large fine.
Source: https://mjbizdaily.com/new-mexico-cannabis-operator-fined-loses-license-for-alleged-biotrack-fraud/
Four marijuana companies, including a multistate operator, have filed a lawsuit against U.S. Attorney General Merrick Garland in which they allege the federal MJ prohibition under the Controlled Substances Act is no longer constitutional.
According to the complaint, filed Thursday in U.S. District Court in Massachusetts, retailer Canna Provisions, Treevit delivery service CEO Gyasi Sellers, cultivator Wiseacre Farm and MSO Verano Holdings Corp. are all harmed by “the federal government’s unconstitutional ban on cultivating, manufacturing, distributing, or possessing intrastate marijuana.”
Verano is headquartered in Chicago but has operations in Massachusetts; the other three operators are based in Massachusetts.
The lawsuit seeks a ruling that the “Controlled Substances Act is unconstitutional as applied to the intrastate cultivation, manufacture, possession, and distribution of marijuana pursuant to state law.”
The companies want the case to go before the U.S. Supreme Court.
They hired prominent law firm Boies Schiller Flexner to represent them.
The New York-based firm’s principal is David Boies, whose former clients include Microsoft, former presidential candidate Al Gore and Elizabeth Holmes’ disgraced startup Theranos.
Similar challenges to the federal Controlled Substances Act (CSA) have failed.
One such challenge led to a landmark Supreme Court decision in 2005.
In Gonzalez vs. Raich, the highest court in the United States ruled in a 6-3 decision that the commerce clause of the U.S. Constitution gave Congress the power to outlaw marijuana federally, even though state laws allow the cultivation and sale of cannabis.
In the 18 years since that ruling, 23 states and the District of Columbia have legalized adult-use marijuana and the federal government has allowed a multibillion-dollar cannabis industry to thrive.
Since both Congress and the U.S. Department of Justice, currently headed by Garland, have declined to intervene in state-licensed marijuana markets, the key facts that led to the Supreme Court’s 2005 ruling “no longer apply,” Boies said in a statement Thursday.
“The Supreme Court has since made clear that the federal government lacks the authority to regulate purely intrastate commerce,” Boies said.
“Moreover, the facts on which those precedents are based are no longer true.”
Verano President Darren Weiss said in a statement the company is “prepared to bring this case all the way to the Supreme Court in order to align federal law with how Congress has acted for years.”
While the Biden administration’s push to reschedule marijuana would help solve marijuana operators’ federal tax woes, neither rescheduling nor modest Congressional reforms such as the SAFER Banking Act “solve the fundamental issue,” Weiss added.
“The application of the CSA to lawful state-run cannabis business is an unconstitutional overreach on state sovereignty that has led to decades of harm, failed businesses, lost jobs, and unsafe working conditions.”
Alabama regulators are targeting Dec. 1 to award the first batch of medical cannabis business licenses after the agency’s first two attempts were scrapped because of scoring errors and litigation.
The first licenses will be awarded to individual cultivators, delivery providers, processors, dispensaries and state testing labs, according to the Alabama Medical Cannabis Commission (AMCC).
Then, on Dec. 12, the AMCC will award licenses for vertically integrated operations, a designation set primarily for multistate operators.
Licenses are expected to be handed out 28 days after they have been awarded, so MMJ production could begin in early January, according to the Alabama Daily News.
That means MMJ products could be available for patients around early March, an AMCC spokesperson told the media outlet.
Regulators initially awarded 21 business licenses in June, only to void them after applicants alleged inconsistencies with how the applications were scored.
Then, in August, the state awarded 24 different licenses – 19 went to June recipients – only to reverse themselves again and scratch those licenses after spurned applicants filed lawsuits.
A state judge dismissed a lawsuit filed by Chicago-based MSO Verano Holdings Corp., but another lawsuit is pending.
Source: https://mjbizdaily.com/alabama-plans-to-award-medical-cannabis-licenses-dec-1/
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