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Medical Marijuana Act Raises Thorny Challenges for Commercial Landlords

Landlords and tenants should be prepared to address issues that include security, lender and insurance concerns, objections from other tenants, lease termination, tenant improvements, payment, and impacts on CAM

In November 2010, Arizona voters passed the Medical Marijuana Act, which legalized the sale of limited quantities of medical marijuana to qualifying patients throughout Arizona.

Medicinal marijuana raises a host of issues ranging from licensing to landlord-tenant/real estate concerns to employee workforce use. Licensing is subject to regulation by rules that have already been promulgated – and likely will be amended and refined – by the Arizona Department of Health Services (DHS).

Medical Marijuana in Arizona: The Dispensary Application Process and Medical Marijuana Dispensary Update

More about Sacks Tierney's Marijuana Business Law practice

Less clear is how the Medical Marijuana Act affects the landlord-tenant relationship and the precautions a landlord can take when faced with the opportunity of renting to an individual or entity that seeks to cultivate and distribute medical marijuana.

Background

Before we discuss the landlord-tenant issues, it might prove useful for us to discuss some background topics, including the pending legal challenges that could delay implementation of the Act or undermine it altogether. (If you prefer, you can skip ahead to the landlord-tenant discussion.)

Conflicts with Federal Laws, Policies. It is important to point out that the rules and procedures in Arizona for growing and selling marijuana almost certainly contravene Federal law dealing with controlled substances. The current administration does not appear to be eager to prosecute (for violations of Federal laws) qualifying patients who comply with the Medical Marijuana Act (for fear, perhaps, of a test of the supremacy doctrine). Large distribution operations, however, may be a different story. Furthermore, while the current administration has adopted a more relaxed approach to enforcing Federal laws against people complying with a state-run medical marijuana program, future administrations may take a much stricter approach to enforcement. (Incidentally, if your shopping center or facility is located on a reservation, the thinking is that the Federal government is not going to look the other way.)

Dispensaries. As currently structured, medical marijuana will be sold to qualifying patients, for the most part, through registered non-profit dispensaries. (It is not clear whether the dispensaries will look like pharmacies or like head shops – perhaps more the former than the latter.) There will be a limited number of dispensaries throughout the state – approximately one dispensary for every ten traditional pharmacies. During the first phase of dispensary registrations, the DHS is limiting dispensaries to one for each “Community Health Analysis Area” (CHAA). The boundaries of each CHAA are based largely on population, and allowing one dispensary per CHAA is designed to spread the dispensaries across the state in accordance with population density.

Landlord-Tenant Issues

Notwithstanding the challenges to the Act's implementation, we believe it important to discuss the real estate issues associated with the Act so that property owners and tenants can plan appropriately.

Special Use Permits. Most of the activity so far has revolved around zoning or special use permits. Under the new legislation and the corresponding regulations, cities cannot prohibit the operation of dispensaries altogether. However, cities are allowed to enact reasonable regulations and restrictions on the use and operation of the dispensaries, and a number of cities have already done so.

Generally, these restrictions are similar to the statewide restrictions relating to liquor stores – distance from schools and churches, special setback requirements, and the like. We have all read about and perhaps attended land-use hearings in which residents take the position that they don’t want any dispensary in their city, and certainly nowhere near their homes (similarly, some businesses that are located near a proposed dispensary also oppose the granting of the applicable zoning and/or special use permit).

As mentioned above, a jurisdiction cannot simply refuse to grant permission, but anyone who frequently attends zoning hearings knows that virtually anything can happen – and it is not going too far out on a limb to predict that we will see litigation challenging jurisdictions that try to be overly strict.

Of interest to landlords is the prospect that a jurisdiction being asked to grant a special use permit or zoning request may require that the dispensary’s landlord approve or sign on to the application of the dispensary operator. Owners of places that are likely locations for dispensaries – e.g., shopping centers, medical office complexes, light industrial sites – may face a number of real estate issues, most of which will need to be resolved in the lease negotiation and documentation. Here are a few issues on which landlord might want to focus.

Security Issues. State rules require a number of 24/7 security measures, including the use of video cameras, alarm systems and exterior lighting. Also, it seems likely that many local zoning ordinances will require that the dispensary provide additional security beyond that required by state law.

In negotiating leases, landlords might want to include more inspection rights than usual, to check for items ranging from fire hazards to indoor air circulation and air quality. However, a landlord will be precluded from inspecting some areas of a dispensary or cultivation operation unless accompanied by an authorized dispensary agent. The lease should deal with the additional expenses involved – presumably, this would not be a CAM charge, but rather the tenant would bear the additional expenses of the extra security – but that is all subject to negotiation.

Lenders. For many projects, the loan documents require lender approval of the leases. There is some thought in the industry that some lenders would rather not have dispensaries in their tenant mix.

Insurance. The same can be said for insurance. Many landlords have blanket insurance on the entire project, and some insurance companies not only have to be notified, but may choose not to insure. Further, it is unclear whether a tenant can obtain “tenant insurance” of any type if the tenant is known to be violating Federal drug laws.

Other Tenants. On the subject of tenant mix, landlords will need to deal with the existing tenants (and keep in mind future tenants), some of whom may not want to have a dispensary near their business or in their center. Some larger tenants may even have approval rights over certain types of tenants.

Lease Termination. In addition to usual protections that landlords try to get (for example, personal guaranties), there is some concern that, especially with the potential Federal law problem, leases may wind up being prematurely terminated, and any lease should deal with that issue.

Tenant Improvements. Needless to say, tenant improvement dollars are often a part of any commercial lease negotiation. Dispensaries, especially those producing marijuana on site, are likely to have very unique TI’s that are unsuitable for a replacement tenant after the lease expires or is terminated. A landlord that is paying for all or part of the TI’s might want to look for a (guaranty) payback if there is an early termination of the lease.

Payment. Oddly enough, there may be difficulties in actually paying the rent. In other states with medical marijuana laws, some dispensaries have had trouble opening bank accounts, since banks are wary of dealing with what might be called “drug money” (especially since the activity is, at least technically, a violation of Federal law). In fact, American Express recently announced that it would decline transactions for the purchase of medical marijuana. While this will initially affect qualified patients more than dispensaries, such limitations by financial institutions may also apply to business expenses (such as rent) for dispensaries and cultivation sites. This might become particularly interesting where there is a lockbox situation in place.

Parking Ordinances. Some observers speculate that parking ordinances will overburden parking lots. The basis for that concern is unclear, but there has been some commentary on that point.

Other Issues. Landlords will have to deal with such mundane issues as the disposal of waste products, such as equipment, chemicals or excess inventory. If the inventory will be “produced” on site, both landlords and their insurance companies should be wary of fire (growing marijuana requires a significant amount of lighting) and on-site chemical storage, not to mention the potential effect on CAM of excess power consumption.

Landlords should be especially cognizant of disclaiming warranties of suitability and warranties for this particular use, wanting the tenant to take the risk that the tenant will not get the required permits (or later be shut down).

Landlords affirmatively seeking to have a dispensary as a tenant should also consider the legality and feasibility of entering into conditional leases with multiple dispensary applicants and executing the lease with the party that is ultimately awarded the right to operate a dispensary. While state regulations do not prohibit such conditional leases, a landlord should thoroughly investigate whether local ordinances would preclude conditional lease agreements.

Many of these issues are relevant not just in a landlord/tenant scenario, but also where the dispensary operator actually owns the site.

If you have questions about the issues discussed in this article or other topics related to medical marijuana, please contact Steve Benson or Mike Rooney.